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Why Trump is winning his war with the Federal Reserve

Posted at 4:03 AM, Jul 26, 2019
and last updated 2019-07-26 11:11:12-04

President Donald Trump may finally get his wish for the first interest rate cut in a decade, a year after he initially chastised Federal Reserve Chairman Jerome Powell.

Yet that highly anticipated policy decision will be far less the result of the President’s unprecedented public assault on the Fed, including demands not to “blow it,” than the product of tremendous uncertainty caused by the Trump administration’s erratic trade war with China and other countries, which has weakened global growth and dampened investment.

Analysts expected markedly weaker growth numbers Friday for the second quarter, adding to the pile of worries central bankers already had about global softening.

The US economy grew at an annual rate of 2.1% in the second quarter, the Commerce Department announced Friday. That’s better than economists had expected, but slower than the 3.1% pace in the first quarter.

Trump quickly jumped at the chance to pin the weaker growth reading on interest rate policy. “Not bad considering we have the very heavy weight of the Federal Reserve anchor wrapped around our neck. Almost no inflation. USA is set to Zoom!” he said on Twitter.

Powell and other Fed governors have already telegraphed they plan to move ahead with a cut when they hold their regular two-day meeting next week, a reversal from earlier plans to steadily raise interest rates this year.

“It’s pretty easy to explain the Fed’s pivot with factors other than Trump talking,” said Kevin Burgett, an economist at Monetary Policy Analytics. “He’s going to be right, or get what he wants at some point, but not because of the pressure but because things have evolved in that way.”

Central bankers around the world, including in the US, are also struggling to understand why inflation has remained muted, propelling officials to move toward cutting rates to get ahead of any economic calamity.

The Fed has dramatically shifted its trajectory on setting interest rates since Powell assumed his role as chair in February 2018. After years of the country’s interest rates stagnating, the central bank began to move toward gradually raising them amid signs of a stronger US economy. Officials touted a slow pickup in wage growth and inflation and a booming job market.

But over time the US economic picture has begun to deteriorate as the fiscal stimulus from Trump’s 2017 tax cut package and massive spending bill tapered and the administration slapped billions of dollars in tariffs on China in an escalating trade war.

“What we saw in the second half of last year really changed the picture,” said William Foster, vice president and senior credit officer at Moody’s Investors Service.

Shifting messages

Plans rolled out by the Fed in December to continue gradually raising rates in 2019 also unnerved investors, triggering a market selloff as they feared the Fed was brushing aside the potential impact of a trade war with China and wondered, “How bad can this get?”

“Investors started to get really concerned about the Fed’s messaging that it was going to continue to tighten, despite what appeared to be increasing risks to the global economy,” said Foster. “That ultimately spooked the market in a way that they thought the Fed might be precipitating a recession.”

By its next meeting, in January, Powell’s Fed was beginning to send a different message to Wall Street, assuring investors it would not press ahead with further rate hikes unless it was sure they wouldn’t damage the recovery.

“The Fed, in my opinion, always pays way too much attention to the stock market,” said Douglas Holtz-Eakin, president of the American Action Forum, an independent economic think tank. “They shouldn’t pay zero. But they pay way more than zero, and the President is obsessed with it, and he yells at the Fed, and this feedback loop is a bad one, from the point of view of the fundamentals of policy.”

But the case for a rate cut has strengthened since policymakers met in May. At the time, it appeared trade tensions were finally easing between the United States and China and there were signs of welcome global growth.

Then that trajectory abruptly changed. Talks between the world’s two largest trading partners collapsed and signs of a slowdown in Europe and China began to emerge. And while talks between the two countries have more recently resumed, they remain far from reaching any resolution.

Powell has delicately tried to avoid pinning the Fed’s rationale for a rate cut directly on the President’s trade wars, pointing more broadly to weakening global growth and inflation struggling to meet the central bank’s 2% target. He’s also sought to make the case that the Fed, along with the other central banks around the world, must act sooner rather than later to get ahead of a downturn.

“If you see weakness, it’s better to come in earlier rather than later,” Powell said in an appearance before the Council on Foreign Relations in late June. “I think most central banks would want to act preemptively and not let a downturn gather steam, in a sense, the thought being an ounce of prevention is worth a pound of cure.”

Little wiggle room

Krishna Guha, who heads global policy and central bank policy as vice chairman of Evercore ISI, says central bankers today know they have much less room to respond with interest rates at historically low levels coupled with subdued inflation. The federal funds rate, which affects the costs of credit cards, mortgages and other borrowing, hovers between 2.25% and 2.5%.

“Because you have a limited amount of ammunition, you shouldn’t wait until things get too bad,” said Guha. “You should be willing to act early, act aggressively, act preemptively even when this is mostly in the dimension of risks rather than economic weakness that is actually materialized and in concrete form because you’ll have more impact that way. You’ll get more bang for your buck.”

Investors will be hanging on Powell’s message Wednesday, listening for whether he expects to deliver a second cut later this year and what the Fed plans next.

Markets swooned last week after New York Fed President John Williams delivered a speech making the case for central banks to act more aggressively and take precautionary measures based on 20 years of history. Investors interpreted his remarks as a case for a possible 50-basis point cut, an unlikely outcome.

Still, not all policymakers are in agreement with Powell’s plans just yet. Boston Fed President Eric Rosengren told CNBC last Friday that he’s not in favor of a rate cut next week, saying the economy is not showing signs it’s necessary at this time. Others — like St. Louis Fed President James Bullard — had already been urging policymakers to make a so-called “insurance” cut to buffer any potential weaknesses in the economy.

“Trade uncertainty used to be relatively low,” Bullard said in an exclusive interview with CNN’s Julia Chatterley on “First Move.” “The President moved it to the front burner. Now I think trade uncertainty is high, and I don’t see that declining anytime soon.”