A New Tool for Bullying the Fed — Trade Wars
Originally published on June 7, 2019 at https://www.vodiacapital.com.
Federal Reserve Chairman Jerome Powell announced on Tuesday that in face of the trade uncertainty, the Federal Reserve would “act as appropriate to sustain the expansion”. Investors interpreted this as an indication that a rate cut by the end of the summer is likely, sending short term interest rates plummeting, and stocks soaring. Such is the power of even seemingly innocuous statements by the Fed Chairman.
The remainder of the speech, dedicated to the perils of the low interest rate environment we’ve been living in for the past 10 years, went mostly overlooked. According to Powell, the proximity of interest rates to zero “has become the preeminent monetary policy challenge of our time”. This proximity means that the Fed’s primary historical tool, the benchmark Fed rate, has limited effectiveness as negative interest rates are of questionable efficacy. According to Powell, this forces the Fed to adopt new tools, such as quantitative easing, whose “efficacy, costs, and risks remain less well understood than the traditional approaches to central banking”.
On the surface, a rate cut seems unmerited by nearly every macroeconomic indicator. The U.S. has demonstrated strong economic growth, averaging 2.47% in GDP growth over the past four quarters. Unemployment is at a historically low 3.6%, and 12 month inflation is at 2.0%, well within the Fed’s target. Why, with such precise execution on its mandate of full employment and low inflation, would the Fed consider a rate cut by the end of the year?
The answer is, of course, the trade war. Powell’s statement comes after months of failed trade negotiations with China. However, it was President Trump’s threat from last week to impose a 5% tariff on imports from Mexico in response to the immigration crisis, that sent the markets into turmoil.
Unlike the trade war with China, or the renegotiation of NAFTA, this new salvo against Mexico has nothing to do with trade, and everything to do with politics. The NAFTA 2.0 arguably addresses some of discriminatory aspects of the original agreement, by setting wage standards and closing loopholes around goods coming in from NAFTAcountries but produced predominantly outside of North America, namely in China. And the negotiations with China, while misguided in tone and style, have the potential of leveling the trade playing field between the two nations.
But in imposing tariffs on Mexico to address immigration, Trump is wielding tariffs as a cudgel to address an issue he’s failed to address by more conventional means. In doing so, he is blurring the traditional division of power between Congress and the White House, and their respective responsibilities for immigration policy and foreign relations.
Even more acutely, Trump is demonstrating his willingness to jeopardize the economic stability of the U.S. in order to win points with his base, ignoring the fact that they are likely to be hit the hardest by an economic downturn.
Perhaps inadvertently, or perhaps by design, Trump’s tariffs may have succeeded where months of bullying have failed. The Fed, which valiantly withstood months of intense pressure by the President, who consistently admonished it for not lowering interest rates to further stoke the overheated economy, now sees real economic danger in the President’s actions. Never mind the perils of going into a recession with a historically low interest rate, the important thing is that Trump gets to punish Mexico, with a rate cut to boot. The economy be damned.
- AD
