“Monetary policy is in a good place”, Jerome Powell said last month, kicking off his post-FOMC press conference, following the Fed’s third rate cut in a row.
“The current stance of monetary policy is likely to remain appropriate”, he emphasized, adding that “monetary policy acts with a lag” and that “the effects will be realized over time”.
It was a clear indication that, at least for now, the Fed is hoping against hope that fate will smile on them – that trade tensions will continue to ease and that the accommodation delivered over the course of 2019 will be sufficient to inoculate the domestic economy from geopolitical uncertainty and prevent the factory slump from spilling over into services and, eventually, to the labor market.
Relive the October presser
One person who doesn’t agree that monetary policy is “in a good place” is noted rates strategist, legendary FX maven and world renowned economist, Donald Trump.
“People are VERY disappointed in Jay Powell and the Federal Reserve. The Fed has called it wrong from the beginning, too fast, too slow”, the president seethed, shortly after Powell’s October presser. “Others are running circles around them and laughing all the way to the bank”, Trump went on to claim, on the way to reiterating his long-standing contention that “We should have lower interest rates than Germany, Japan and all others”.
Were the Fed to acquiesce to the president’s demands, the US would have deeply negative rates, a situation Trump has variously suggested should be engineered into reality in order to allow Steve Mnuchin to “refinance our debt“. (Janet Yellen called that idea “long rejected” in September.)
Powell and Trump will deliver dueling remarks on the economy this week, with Trump up first on Tuesday, and Powell scheduled to address Congress on Wednesday and Thursday.
The real test for the notoriously fraught relationship between Trump and his Fed chair will come in 2020, though, when the Fed is widely expected to remain on hold barring an unforeseen deterioration in the economy or another escalation on the trade front.
The problem for Trump is obvious – his leverage over US monetary policy hinges on his ability to engineer trade uncertainty, but any further escalations with China (or with the EU on auto tariffs for that matter) risks undercutting the economy in an election year.
With the US growing at a 1.9% clip (according to the advance read on Q3 GDP), the White House can ill-afford further deceleration. After all, Trump has promised to deliver an economic renaissance, and while his pro-business policies did produce the expected sugar high in 2018, the economy has virtually no chance of growing at a 3% clip sustainably as promised by the president, Larry Kudlow and other supply-side sock puppets.
The good news is, recent data suggests the US economy is on firmer footing than market participants thought just three months ago. The bad news, again, is that things are clearly cooling off and Trump will be loath to accept anything less than a screeching tea kettle headed into the election. To get that, he’ll need to compel the Fed to cut rates further.
If Powell and company were to hold off, content in the notion they’ve done enough and keen to avoid further charges of politicization, it would actually mark a break with precedent. “Rather than keeping its head down, the Fed has changed policy in one direction or another in each of the last 10 presidential polling years — though in 2016 it didn’t act to raise interest rates until after the November election”, Bloomberg notes on Tuesday.
Powell made it abundantly clear last month that it would take a rather dramatic spike in inflation to put rate hikes back on the table. “We would need to see a really significant move up in inflation that’s persistent before we would consider raising rates to address inflation concerns”, he remarked.
That’s the good news for Trump. The bad news is that while the bar for additional cuts may well be much lower than the bar for hikes, the Fed is acutely aware of the extent to which Trump’s incessant badgering will make lawmakers especially sensitive to any accommodation delivered in 2020 above and beyond what can be clearly justified by the incoming data. The irony is always the same: Trump has made it harder on himself by publicly deriding Powell. Now, any attempts to coerce the Fed chair in 2020 will be scrutinized relentlessly, even as Americans have become largely numb to the president’s weekly exhortations to monetary policy easing.
Wall Street is somewhat divided on what comes next for the Fed. In the immediate aftermath of the October cut, postmortems from the major banks ran the gamut from expecting three additional cuts to no more easing at all.
“Whether the Fed remains on hold or delivers additional cuts and stops there – either way, we face a realistic possibility of a protracted period of inactive Fed in the near term or beyond”, Deutsche Bank’s Aleksandar Kocic writes, in his latest missive. “Even if we have a new administration after the 2020 presidential elections and a radically different proposal for fiscal stimulus on the table, it will take some time before a need for a meaningful adjustment of monetary policy emerges”.
If that turns out to be the case, it will have important implications for the mode of the curve. An inactive (or less active) Fed means “shocks no longer arrive at the front end of the curve and propagate to the back end [giving] rise to bull steepeners (BuS) or bear flatteners (BeF)”, Kocic goes on to say, revisiting a theme he’s discussed at length in the past.
Instead, a Fed that stays on hold means curve dynamics will be defined by bull flatteners (BuF) and bear steepeners (BeS) “as the back-end metabolizes expectations of growth and inflation while the front end remains anchored”, Kocic notes, illustrating the point as follows:
The implication (in case it’s not obvious) is that an inactive Fed means the slope of the curve moves in tandem with the long-end – selloffs and rallies are then steepeners or flatteners, respectively.
Assuming growth and inflation expectations remain subdued, that would appear to bias things towards bull flattening, any near-term extension of the long-end selloff tied to fleeting trade euphoria and position adjustments notwithstanding.
Who knows, maybe we’ll even find ourselves laughing at another “CRAZY INVERTED YIELD CURVE” six months from now.