At one point on Wednesday afternoon, during his formal press conference with Polish President Andrzej Duda, Donald Trump told reporters that when it comes to whether there’s a deadline for China to return to the table for trade talks, “I have no deadline”.
Then, without missing a beat, Trump said “My deadline is what’s up here”. He pointed to his brain. “Nobody can quite figure it out.”
He’s right. Nobody can quite figure it out. Least of all the Fed, which is staring down a dilemma as vexing as it is absurd.
The president is either i) crazy, and fully prepared to let his “Tariff Man” alter ego blow up the global economy, ii) conniving, and only bluffing about blowing up the global economy in order to trick the Fed into rate cuts ahead of an election year, iii) some combination of crazy and conniving.
At the same time, Trump has all but stripped the Fed of plausible deniability when it comes to preemptive policy easing. Thanks to a year’s worth of harassment, Jerome Powell cannot cut rates without risking allegations of pandering to a president who, with each passing day, drags America a little further down the road to authoritarian government.
An extra layer of complexity is introduced when you ponder the possibility that preemptive Fed cuts could exacerbate the very global economic swoon they’re designed to prevent. If Trump believes he’s got Fed cover, he may escalate things further, resorting to more tariffs. An all-out trade war would crush growth but would likely push up consumer prices. At that point, there is no adequate monetary policy response.
On Sunday, in “Powell Fed Faces ‘Political Event Horizon’ – And Crossing It May Mean No Way Back“, we brought you some quotes from the latest by Deutsche Bank’s Aleksandar Kocic, who last week talked about the Fed getting “dragged into becoming a permanent part of the policy mix with all the implications that role entails.”
In the same note, Kocic posits two possible roles for the Fed in the “recentering of trade policy”, where one is permanent, the other transitory. In the latter situation, the Fed delivers one, or perhaps two, insurance cuts in order to offset the initial shock. After those cuts, the Fed returns to its mandate.
The other possibility is far more consequential. “The Fed [could] continue to subsidize the markets in the context of permanent long-term effects introduced by the changes in trade policy”, Kocic writes.
Of course, it’s possible that the Fed could initially conceive of its role as simply offsetting shocks, only to look up years later and discover that it has become inextricably bound up with the policy mix. Kocic draws a parallel with 2007 in that regard. To wit:
If we are to draw lessons from history (which has been a poor teacher so far), at the start of the 2007 crisis, the Fed initially acted as a circuit breaker with an intention to offset the effects of financial shocks. We know how that turned out in subsequent years. Due to depth and severity of the crisis that unfolded, Fed was dragged into the role of subsidizing the financial markets.
But the Fed exacted a price for that – namely, regulations that sought to rein in excesses in the financial sector. “These present the down payment for forcing monetary policy to subsidize the markets”, Kocic says, before conceiving of a similar situation when it comes to politics. “The same causality chain applied to the present situation would suggest that deepening of the current crisis to the point that it requires a protracted or permanent shift to accommodative monetary policy would come with a need for regulations with intention to protect the markets from political excesses”, he says.
In the interim, the Fed and traders are at the mercy of increasingly erratic politics and, as Kocic goes on to point out, recent events appear to suggest that while the two-way communication loop between monetary policy and markets is still functioning, “the communication between politics and the Fed or between politics and the markets is only one way — a monologue — without any feedback into politics.”
Previously, it was possible to conceive of a kind of “countercyclical protectionism“, where the Trump administration became more hawkish on trade the higher the market flew, and more conciliatory when equities sold off.
Recently, though, Trump appears to have adopted a less predictable approach – as he put it on Wednesday, “Nobody can quite figure it out.”
That, in turn, means a sharp economic downturn may be the only thing that restores an active, two-way dialogue between politics and the other two points on the triangle (markets and the Fed).
“Unlike the market/Fed branch, where the stock market for example could be a circuit breaker, there doesn’t seem to be a similar circuit breaker between politics and the other two corners of the triangle. At least not for now”, Kocic writes. “The only possible candidate in this context is the growing probability of recession.”