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Trump swinging at the Fed
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Trump swinging at the Fed

Joe Bailey Project Finance & Infrastructure, Weekly bulletin July 2018

While President Putin seemed to get off particularly lightly in his recent personal meetings with Donald Trump in Helsinki, the same can’t be said of Fed chair Jay Powell. In a wide-ranging interview with CNBC’s Joe Kernen the US president took aim at Powell, and the Fed more widely, for raising interest rates just as the economy in the US is taking off.

Fortunately for Powell, he has not yet had to meet the first president since the 1990s who threatens not to respect and maintain the intended impartiality of the US central bank. The last president to take significant steps in this direction was Nixon, who forced his Fed chair to loosen into the 1972 presidential election. Reagan did not go quite so far, but did publically criticise Volcker in the early 80s as he thought, much as Trump now argues, that the series of (more severe) rate rises were tempering the effects of tax cuts made by his administration. The hawkish tone set by Volcker is generally accepted, in part at least, to be a direct effect of the politically motivated loosening a decade prior – hence the requirement and expectation of central bank independence.

Given President Trump’s preoccupation with his influence on the S&P 500, he will likely have been much more concerned by the fact that US stocks retreated while he was speaking than by the historically inauspicious ground covered in the interview. Even with both things considered, though, the most notable aspect of his remarks is that he did not distance himself from them after the fact – as he is frequently happy to do – and instead backed them up the following day via tweet:

“The United States should not be penalized because we are doing so well. Tightening now hurts all that we have done. The U.S. should be allowed to recapture what was lost due to illegal currency manipulation and BAD Trade Deals. Debt coming due & we are raising rates – Really?”

Powell certainly seems to be between a rock and a hard place because it is not overwhelmingly clear that short term rates should continue to be hiked in the US. The current debate around the shape of the yield curve in the US is both important and unresolved. In Powell’s testimony to congress last week he was insistent that the Fed is on the correct (hiking) path, implying another 0.25% increase in September and a further one (the fourth) in December this year. At the same time, questions are being asked about the flattening bond yield curve. The spread between 2 and 10-year Treasury bonds is around 25bps and thereby the lowest since the beginning of the financial crisis. Historically a flattening yield curve has signalled the an impending recession.

Ironically, Trump’s outburst could harden the chair’s resolve to stay the course of raising rates in a bid to maintain his all-important professional impartiality to political interference. Markets will no doubt be trying to consider Powell’s motives for his policy, including the influence of the President, adding an additional layer, previously not considered, to reading the Fed’s predicted rate path.

Given how accustomed to cheap debt, low rates, QE, and stock buybacks investors have become, it is little wonder markets have stayed so high for so long. Should the economy or the stock market look to falter towards recession, Trump will remind the voting public that he didn’t support the hikes. Powell could well then become a scapegoat for the natural cycle and an (arguably) long overdue correction – a particularly bitter pill given that equal blame could be placed with Trump’s own trade wars or a rising Dollar (the latter the inevitable result of the president’s tax cuts, of course). In such a scenario Powell and the Fed – as evidenced by the flattening yield curve – will in fact have the ability to reverse its policy position and slash rates as required. This is a lot more than can be said of most other central bankers outside the US, all of whom potentially face a similar slowdown but have yet to begin the rate hiking cycle in anything approaching earnest.

 

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