On Friday, the Wall Street Journal reported that Donald Trump is displeased with Treasury Secretary Steve Mnuchin.
That displeasure allegedly stems from Steve’s reservations about the trade war and also from Mnuchin’s support of Jerome Powell, who Trump has lambasted on any number of occasions over the past four months, with the latest broadside coming Tuesday evening in comments delivered during a rambling interview with the Washington Post.
According to the Journal’s Friday reporting on the Mnuchin situation, Trump said this of Powell during a conversation about recent market turmoil: “If he’s so good, why is this happening?”
Well, according to Bloomberg, Mnuchin was running around to bond dealers last month essentially polling them on which they’d prefer: rate hikes or a faster balance sheet run off.
It sounds like Mnuchin was (or is) hoping that Trump understands so little about post-crisis monetary policy that he won’t mind if the Fed accelerates the pace of balance sheet normalization if it means slowing down on rate hikes. The President, one assumes, will not view tightening via accelerated balance sheet runoff as something that could imperil the economy and the stock market.
“In an October 30 meeting with a Treasury advisory committee that makes recommendations to the government quarterly on its debt sales, Mnuchin asked which they favored — an accelerated balance sheet run-down or further rate hikes — if they had to choose one or the other”, Bloomberg reports, citing six people familiar with the situation, and adding that “Mnuchin raised the question during a regularly scheduled quarterly meeting with the Treasury Borrowing Advisory Committee.”
So basically, Mnuchin is now asking Goldman, JPMorgan and (hilariously) Citadel the following: “Ok, guys, show of hands. Who wants rate hikes and who wants accelerated balance sheet rundown?”
Of course this is extremely precarious and it’s surely not lost on Mnuchin that if the Fed were to placate Trump by eschewing rate hikes in favor of a faster pace of balance sheet runoff, it would make his job all the more difficult because it would mean even less support for the bond market at a time when the Treasury is flooding the market with supply to finance the deficit and direct bidders are drying up.
Remember, Steve now holds the refunding record, having snatched the dubious title from Tim Geithner this quarter and the less support there is from the Fed when it comes to the U.S. debt market, the harder it’s going to be for Mnuchin to finance Trump’s fiscal insanity.
But wait, there’s more!
Recall what the RBI’s Urjit Patel wrote in an Op-Ed for FT earlier this year about the extent to which the Fed should calibrate the pace of the balance sheet rundown to take account of increased Treasury supply:
Dollar funding of emerging market economies has been in turmoil for months now. Unlike previous turbulence, this episode cannot be attributed to the US Federal Reserve’s moves on interest rates, which have been rising steadily since December 2016 in a calibrated manner.
The upheaval stems from the coincidence of two significant events: the Fed’s long-awaited moves to trim its balance sheet and a substantial increase in issuing US Treasuries to pay for tax cuts. Given the rapid rise in the size of the US deficit, the Fed must respond by slowing plans to shrink its balance sheet. If it does not, Treasuries will absorb such a large share of dollar liquidity that a crisis in the rest of the dollar bond markets is inevitable.
That dynamic would worsen if the Fed were to accelerate the pace in the face of record debt issuance.
Further, most believe the Fed will be forced to halt balance sheet normalization altogether sooner rather than later and the market is on pins and needles waiting for details on the technicalities. EFFR continues to drift and eventually, the Fed is going to have to address it.
In the final analysis, this is just another example of Donald Trump backing everybody into a corner by either not understanding what’s going on or else insisting on pushing competing policy goals.
Finally, do note that even if Mnuchin and Powell could fool Trump, they can’t fool the market, which would invariably see accelerated balance sheet rundown for exactly what it is: more tightening at a time when the total degree of tightening is at or above levels where a recession normally ensues (see left pane below).