Reuters International

Republican U.S. presidential candidate Donald Trump speaks during a campaign rally in Lynden, Washington, U.S., May 7, 2016. REUTERS/Jim Urquhart

(reuters_tickers)

By Ann Saphir and Lindsay Dunsmuir

SAN FRANCISCO/WASHINGTON (Reuters) - Donald Trump's rise to de-facto Republican nominee for president poses an unusually high level of uncertainty for investors and businesses, potentially weighing on the economy and the Federal Reserve's plan to raise interest rates this year.

Uncertainty is always present in elections and the Fed has hiked rates during past campaign seasons. (Graphic: http://tmsnrt.rs/1rD6A1u)

But the possibility of the firebrand New York real estate mogul occupying the White House presents a step up in risk because of the unconventional policies he has proposed and a lack of detail on how they will be achieved, economists say.

Promising to "make America great again", Trump has raised fears of a trade war by saying he would slap steep tariffs on Chinese and Mexican imports. He has also vowed to deport all 11 million undocumented migrants in the United States, and suggested, though later retracted, a partial default on U.S. debt.

Fed officials say they avoid discussion of domestic politics at rate-setting meetings. Transcripts from previous election-year policy discussions show that political uncertainty is a factor in their thinking, though there no clear pattern of a loosening or tightening bias in the run-up to elections.

In recent comments, some Fed officials have acknowledged that campaign rhetoric could spill over into the economy.

"If consumers, because of political rhetoric, are slowing their spending or just pausing a little bit, or capex is slowing down...that I've got to take into account," Dallas Fed President Robert Kaplan told Reuters last Thursday.

Asked his view of Trump's policy proposals, he said, “If I have one, you’ll never know what that is. I will never allow that to seep into my work.”

Atlanta Fed President Dennis Lockhart said that it was fair to say the election "could be a factor in this year's economy."

The Fed kept rates on hold at 0.25-0.5 percent last month and signalled it was in no rush to raise them again soon, citing slowing economic activity despite an improved labour market. Fed policymakers in March forecast two rate hikes this year after raising them last December for the first time in nearly a decade.

FED KEEPS EYE ON UNCERTAINTY

Fed Chair Janet Yellen and other Fed policymakers have often cited uncertainty over the economic, financial and policy outlook as a factor in their interest-rate decisions. The VIX measure of stock-market volatility is one approach to measuring uncertainty; querying influential business owners is another. The exact mix of measures the Fed uses is not known.

Stanford University professor Nick Bloom's economic policy uncertainty index, which he presented to Yellen and economists at recently as April last year, is another approach that the Fed considers.

The index analyses newspaper coverage of policy-related economic uncertainty and divergence between economic forecasters' predictions on the U.S. outlook among other factors.

"When uncertainty is high, firms put on pause hiring and investment decisions," Bloom said in an interview. "If Trump looks like a serious contender and is still making 'Mexican Wall' and 'Trade Rape' comments we will have the mother of all policy uncertainty spikes running up to the election."

Trump has said he would build a wall on the Mexico-U.S. border and accused China of "raping" the U.S. with unfair trade policies.

A rise in the index, Bloom said, would foreshadow declines in production, investment, and employment.

Policymakers pay close attention to financial market volatility as well as economic data. The Fed delayed an expected hike last September after China's sharp economic slowdown caused stock market drops and a tightening in financial conditions.

A strong Trump candidacy could similarly upset markets, economists say. A Reuters/Ipsos poll released on Wednesday showed Trump running nearly even with Democrat Hillary Clinton among likely U.S. voters, a dramatic turnaround since he became his party's presumptive nominee.

Traders see a 36.5 percent chance of a Republican taking the presidency, according to futures prices on the Iowa Electronic Market.

"If Trump gains in the polls and the market reacts poorly, that (market turmoil) would be a good argument for the Fed to stay on hold," said Cornerstone Macro economist Roberto Perli, a former Fed board staffer.

China and Mexico are the second and third largest trading partners of the United States, respectively.

"The trade stuff is anti-growth and harmful to the U.S. outlook," said Douglas Holtz-Eakin, president of conservative think tank the American Action Forum and a former director of the Congressional Budget Office.

"He's an utterly unpredictable political element at this point," added Holtz-Eakin, who was also chief economic policy adviser to Senator John McCain's 2008 presidential campaign.

Trump, who says his policies will boost U.S. jobs and business interests, has said he likes low rates, but has also said he would replace Yellen when her term expires in 2018 if he wins the presidency.

So far there's little indication Bloom's uncertainty index is about to spike. It fell to a reading of 98.39 in April, just above where it was in November ahead of the Fed's well-telegraphed rate hike. Other readings of uncertainty, like the VIX, look similarly benign. Voters go to the polls on Nov. 8.

Historically, Bloom's index jumps just ahead of tight presidential ballots, as well as during times of other policy uncertainty, such as the U.S. debt ceiling debate in 2011. A surge of 90 points in the index could presage a one percent decline in production and declines in employment and investment of about a half a percent each, based on Bloom's models.

<^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^

Graphic showing past Fed rate moves in election years http://tmsnrt.rs/1rD6A1u)

^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>

(Reporting by Ann Saphir and Lindsay Dunsmuir; Editing by David Chance and Stuart Grudgings)

reuters_tickers

 Reuters International