If Donald Trump was playing “3-D chess” with the Fed before this month, I don’t know what you call what he’s doing now. “12-D chess” maybe?
On August 1, less than 24 hours after Jerome Powell showed a reluctance to countenance market expectations for the launch of a full-on easing cycle, the US president escalated trade tensions with China in an apparent bid to engineer more uncertainty, thereby prodding the Fed into acquiescing further to the White House’s demands for rate cuts. That may not have been the whole plan, put it was certainly part of the plan, although that assumes Trump actually had a plan in the first place, which isn’t a guarantee.
In any event, the president succeeded in irritating Beijing and generating all kinds of market turmoil, leaving investors across assets with an acute case of whiplash.
Tuesday’s relent which found the White House delaying tariffs on some consumer goods until December 15 was a clear nod to the possibility that the next round of duties could push up prices and thereby engender some pushback from the electorate, especially during the holiday shopping season.
As we mentioned, the latest turn in the trade soap opera has implications for the Fed, in that it both decreases and increases uncertainty (in the near-term, the outlook is improved, but the medium-term outlook is now arguably more cloudy than it was on Monday).
On top of that, it makes forecasting the possible effect on inflation even more difficult because now, nobody really knows when, or even if, the products which were spared on Tuesday will ultimately be taxed, and remember, Trump can (and probably will) cast doubt on the time table. For what it’s worth, the numbers show that a little over $155 billion of the $260 billion in Chinese goods targeted in the next round (i.e., the September 1 round) will be safe until December.
Tuesday’s tariff U-turn came just after the latest read on CPI showed core consumer prices rising more than expected in July, throwing yet another monkey wrench into the equation for Jerome Powell. Then, on Wednesday, the 2s10s inverted, sparking a recession cacophony which will surely reach the ears of the president, leading to shrill cries for rate cuts. (God forbid #Recession starts trending on Twitter and he sees it.)
If Trump’s latest swerve in the trade charade represents another move on his multi-tiered “chess” board, then he really is a “stable genius”, because at this juncture, the ship appears totally rudderless to outside observers.
As a friend put it last year, “it feels like Trump’s on a highway driving against the traffic and is pushing the gas pedal. All the cars are moving to the shoulders to avoid confusion, but there’s bound to be a truck which won’t be able to get out of the way quickly enough”. That’s even more apt now than when I first heard it.
Barclays tried to sort through this in a note out Tuesday evening. “We believe the roller-coaster nature of the US-China trade war negotiation process is adding to significant uncertainty and is likely to keep volatility elevated”, the bank said, in what might fairly be described as an understatement.
The problem is that while the market clearly thinks the Fed will come to the rescue, the curve suggests the same markets do not believe that rescue effort will be successful, or else will be hamstrung by incoming data which continues to paint a mixed picture of the domestic economy.
“[There’s] an increased likelihood of Fed being behind the curve, and market expectations of five or more cuts by December 2020 could lead to risk-off in equities (Weaker Fed Put)”, the bank cautions.
Barclays goes on to underscore all the points made above. “Fed Fund futures are already pricing an aggressive 75bp cut by the Fed in 2019, pointing to a full easing cycle, as trade war negotiations have been whipsawing investors, while there is no doubt that US economic growth has been stronger than the rest of the world”, the bank writes, adding that “the current stronger-than-expected US inflation print is likely to add to concerns about the dovish rate cut path the market is pricing in”.
Again, the firming up of inflation and a still-solid labor market makes it very difficult for the Fed to justify aggressive rate cuts, and Trump’s threat to slap tariffs on all kinds of consumer goods made things worse.
Now, Trump has watered down that threat by saying he’ll wait until December 15, but what happens if the data between now and then continues to show consumer prices gradually rising? And what if wage inflation heats up into the end of the year? What is the Fed supposed to do? Cut rates another three times into that knowing that Trump may well decide to pull the trigger on more tariffs once people stop saying “Merry Christmas”?
(Remember, the “war on Christmas” is over now – Trump made it ok to say “Merry Christmas” again, although he almost succeeded in creating a scenario where, for the second year in a row, nobody would be in a good enough mood to regale their fellow Americans with seasons greetings because they’d be paying more at the cash register a year after spending the holidays watching stocks plunge in the worst December selloff since the Great Depression.)
Ultimately, there is no chance of the Fed getting this “right” precisely because there is now no policy mix that is going to produce an overtly positive outcome.
In the best case scenario, the Fed manages to forcibly prolong the expansion and pacify markets with a series of deliberate rate cuts. But that will be seen as an overtly political move into an election year and, worse, it will doubtlessly embolden Trump to perpetuate the trade war, in the fashion of the following loop, which will eventually dead end in a nightmare scenario where “Tariff Man” collapses global trade and drives inflation into the stratosphere:
Barclays is a bit less bombastic in their assessment. “Stronger domestic data/trade war progress is likely to further add to the Fed’s dilemma of having to choose between mid-cycle adjustment vs a full blown rate cut easing cycle”, the bank said, in the same Tuesday note, on the way to reiterating that the schizophrenic character of the tariff negotiations is “impacting global trade and business sentiment and trade wars are spilling over into currency wars [just as] political uncertainty has increased significantly in China/Hong Kong, Argentina, and Italy”.