“We may continue to see escalation of the trade war — with both China and Mexico — until there is sufficient pain in the equity market to prompt President Trump to reverse course”, BofA wrote Friday, echoing their long-standing contention that until US stocks fall enough to convince the White House that things are unraveling in earnest, there will be no end.
Both JPMorgan and Barclays now see Fed cuts in September. Those calls (out Friday, as equities tumbled with bond yields), found the banks citing the Mexico tariffs as something akin to the last straw when it comes to convincing Fed officials that Trump has succeeded in creating enough uncertainty to warrant preemptive rate cuts, even as the labor market remains strong.
The Fed has spent months cultivating the “patient” narrative predicated on subdued inflation. Powell’s “transitory” remarks notwithstanding, the Fed could easily emphasize sluggish inflation in the course of cutting rates to cushion the blow from the incessant escalations in Trump’s multi-sided war.
Two weeks ago, Deutsche Bank’s Aleksandar Kocic explained why this situation is so vexing for the Fed. Here, for those who missed it, is the key quote from Aleks:
An overly accommodative Fed could encourage further escalation of trade wars with more tariffs on one side and, at the same time, erode Fed’s credibility on the other. Further trade war escalation would act as a negative supply shock causing a higher price level ultimately forcing the US consumer to carry the costs of higher tariffs. In this way, temporary stock market stability becomes destabilizing with the economy suffering from higher inflation and lower output which does not have a proper monetary policy response.
Trump has, for the better part of a year, implored the Fed to get on board with the trade war. The president’s most explicit exhortation in that regard came on May 14, when he mused that “China will be pumping money into their system and probably reducing interest rates… in order to make up for the business they are losing.” He went on to say that “if the Federal Reserve ever did a ‘match’, it would be game over, we win!”
It is, of course, not that simple, as Deutsche’s Kocic made clear last month.
With expectations for Fed cuts now proliferating (i.e., with banks changing their official Fed calls, thus coming around to what STIR traders have been saying for six months), BofA echoes Deutsche in suggesting that Powell will likely be wary of jumping in too fast.
“This further escalation of the trade war increases the likelihood that the Fed will have to cut rates to offset the pain from tariffs [but] for the time being, Fed officials will remain ‘patient’ with hopes that there will be a resolution to the trade war in short order”, the bank’s Michelle Meyer wrote Friday.
The Fed, Meyer says, will respond only “slowly” and after the data weakens. That shyness about jumping the gun will be based on two concerns, BofA contends. To wit:
First, they will worry about having to flip flop if the tariffs are quickly reversed. Second, they will not want to encourage further escalation of the trade war and use up more of their scarce ammunition. The market, however, is convinced that the Fed will have to cut, pricing in almost two cuts this year.
The second point the most important. If the Fed cuts in September (or before) it will doubtlessly embolden Trump. That would go double if, say, a 50bp cut (as Barclays expects) catalyzed a market rally.
Remember, in addition to thinking about the Dow as a kind of real-time barometer of his job performance, Trump views equity market gains as an opportunity to “play with the house’s money” when it comes to chancing trade escalations. That means that when things heat up enough to prompt a decline in stocks, he generally tones down the rhetoric, and vice versa.
What he would really like, though, is for the Fed to protect him on the downside (with rate cuts) so that he isn’t constrained by falling stock prices in his capacity to turn the screws on China, Europe and now Mexico.
Presumably, Powell would rather not be involved in that, because the effects on the economy of further trade escalations could be significant, and if the Fed is seen in hindsight as an enabler of the trade war, their credibility in terms of responding to a downturn would be in question.
But Powell may have no choice. Because while everyone assumed the “Trump put” was just 3-4% out of the money when the president endeavored to restart the trade war with China on May 5, it’s become apparent that those estimates were wrong.
“Figuring out [Trump’s] pain threshold is a challenge”, BofA admits. “Clearly it has yet to be reached.”
Trump is like a little boy who has a new toy hammer called tariffs and now is getting a kick out of hammering things. My concern for the market is that he starts to like the immediate response he gets, even if the market goes down temporarily after one of his tweets. He loves the sense of power it gives him.
I think he is pivoting away from “friend of Wall Street and Corporate America” and into “populist leader fighting for American jobs” for the upcoming campaign. Having given Corporate America tax cuts last year, he probably feels safe carrying their ongoing support, despite the current debauchery with the trade escalations. And as H has surmised previously, he’ll just blame Powell for any deep setbacks in the Equity Markets. I picture him sitting in the Oval Office citing Hannibal Smith with “…I love it when a plan comes together.”
Trump is ‘attacking’ Mexico with the 5%/month tariff (he’s still in a funk because he hasn’t yet built his wall and had Mexico agree to pay for it), even putting the hard-fought USMCA in jeopardy, to distract the American public and the ‘lame stream’ media from the Mueller, not not guilty of obstruction of justice public announcement.
This non-sense by Trump is likely to backfire
Pain threshold will be when R support drops below 75-80%. At some point Rs will realize he has no clue and only cares about himself and is doing (and has done) serious damage to this country.