Slowly, but surely, analysts and economists are coming to the begrudging conclusion that Donald Trump is serious when it comes to pushing the envelope on the trade front.
For months on end, Wall Street clung to the notion that rationality would prevail or that, at the very least, the threat of a trade-related market crash ahead of the midterms would compel the President to tap the brakes. But one by one, folks are throwing in the towel.
On Wednesday, JPMorgan’s Michael Feroli raised the specter of the U.S. moving to intervene in the currency market in an effort to push the dollar lower. Trump has decried the current rates dynamic whereby the policy divergence between the Fed and America’s trade partners continues to argue for a stronger greenback, which in turn waters down the effects of the tariffs. “We cannot rule out a turn toward a more interventionist currency policy”, Feroli said.
That would mark a serious escalation just one step removed (conceptually speaking) from the White House demanding rate cuts from Jerome Powell’s Fed which came under direct attack from the President last month.
“Unless Trump can engineer a meaningfully weaker USD, a proper trade war with China would be difficult to win”, JPMorgan’s Marko Kolanovic wrote in a note dated July 30, underscoring the dilemma for a President whose fiscal policies argue for a more hawkish Fed, but who needs a weaker dollar to strengthen America’s hand in the trade conflict.
The world has long feared the Trump administration’s trade stance amounts to a weak dollar policy by proxy. Steve Mnuchin’s comments about the dollar in Davos back in January didn’t do much to allay those fears. Since April, however, Fed hikes, Jerome Powell’s steadfastly upbeat take on the domestic economy and signs that the Trump administration is inclined to keep the pedal to the metal when it comes to doing everything in their power to prolong the expansion have pushed the greenback steadily higher.
In this context, it’s worth noting that dollar longs came off a bit for the first time in six weeks in the week through last Tuesday. Specifically, net USD length fell by around $0.6 billion, perhaps reflecting concerns that Trump will indeed begin to pile more pressure on the Fed ahead of September.
As Bloomberg’s Sebastian Boyd wrote on Wednesday afternoon regarding the prospect of intervention by the U.S., “the problem with currency interventions is that they tend to be very expensive, they don’t work particularly well [and] in any case, a weaker dollar would likely be inflationary despite sterilization because it would boost activity and push up the cost of imports.” He goes on to suggest that a more likely near-term option is more aggressive rhetoric and jawboning from Trump.
This goes back to what we’ve variously characterized as Trump’s dollar “insanity loop“. Both his domestic economic policies and his tariffs are inflationary, at least in the short-term. As Deutsche Bank’s Aleksandar Kocic wrote in a June note regarding late-stage recoveries, “in the past, this stage always exhibited a dramatic (practically straight line) rise in wages in response to infinitesimal improvements in economic activity.”
Throw in the tariffs and the Fed is staring down a particularly precarious dynamic, even as wage growth remains stubbornly suppressed for the time being. “A reversal of trade integration/openness trends implies a steeper Phillips curve, increased sensitivity to domestic economic conditions, higher inflation outcomes in the long term (all else equal) and higher inflation volatility”, Barclays warned, in a note dated June 7.
The more worried about that the Fed is, the more hawkish they’re inclined to be. Trump unwittingly contributes to that angst by holding press conferences to celebrate good economic data – effectively, he’s bragging about his already overt efforts to overheat the economy.
As documented extensively in “Here’s Why You Should Be Concerned About The Latest Escalation In The U.S.-China Trade War“, if Trump does indeed move ahead with the next round of tariffs on an additional $200 billion in Chinese imports, it will become increasingly difficult to avoid driving up consumer prices. “As we saw with tariffs on laundry equipment this year, tariffs on household items could ripple through into retail prices relatively quickly”, SocGen’s Omair Sharif wrote late last month.
And that was assuming a 10% rate in the next round of 301-related duties. Last week, the administration threatened to more than double that to 25%, raising the stakes materially and in the process raising the odds that further escalations will drive up prices for consumer goods, thus risking an inflation overshoot and prompting still more hawkishness from the Fed.
“While the outlook is uncertain, we expect the White House to move forward with tariffs on the majority of the next round of $200 billion in imports proposed in July”, Goldman said, in a note dated Wednesday, assigning a 70% chance to a further escalation. “We expect that the recently proposed 25% tariff rate (up from the earlier proposed 10% rate) will be applied to a subset of the $200 billion of targeted imports”, the bank goes on to say.
Again, Trump is stuck. The more he ratchets up the pressure on China, the more yuan weakness the market expects. The harder he mashes the gas on the U.S. economy, the more justified the Fed is in hiking rates. If the trade jitters start to manifest themselves in slowing global growth, the more justified America’s trade partners would be in adopting an easier monetary policy relative to the Fed, although emerging economies are between a rock and a hard place in that scenario – policy divergence with the Fed can beget capital flight, but rate hikes risk choking off growth even further.
The irony in all of this is that Trump’s ill-advised public attacks on the Fed make it more difficult for Jerome Powell to justify a pause in the hiking cycle. Now, any dovish lean opens the FOMC up to charges of pandering to Trump. It would also raise serious concerns about whether the United States has taken yet another step down the road towards becoming a banana republic.
“We have written before about the resemblance between Donald Trump and some emerging-market leaders — debt-funded pro-cyclical stimulus, attacks on the media, use of social media, etc”, the above-mentioned Sebastian Boyd remarked, in the same short blog post cited above. “A populist currency intervention would fit that pattern,” he added.
As long as the administration continues down the path it’s on now, unwilling to give an inch on anything, the paradoxical dynamics outlined above will persist until Trump moves in to intervene in the currency market. But even then the optics are bad, because after all, Trump hates – hates – currency manipulation.
China, the European Union and others have been manipulating their currencies and interest rates lower, while the U.S. is raising rates while the dollars gets stronger and stronger with each passing day – taking away our big competitive edge. As usual, not a level playing field…
— Donald J. Trump (@realDonaldTrump) July 20, 2018