Markets register a shock, but is Trump right to blame
the Fed?
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[August 15, 2019] By
Howard Schneider
WASHINGTON (Reuters) - It takes a lot to
kill an economic expansion, typically requiring a major shock to bring
growth to a halt and trigger a U.S. recession.
This week investors signaled that moment may have arrived, and one big
question is whether that shock has come from President Donald Trump's
trade war or a mistake by policymakers at the U.S. Federal Reserve.
As bond markets flashed concern about recession on Wednesday and major
stock indices cratered, Trump put the blame squarely on the Fed for
continuing to raise rates through the end of last year. Even Trump foe
and New York Times economics columnist Paul Krugman dinged the Fed for
"a clear mistake."
In raising interest rates four times last year "the Federal Reserve
acted far too quickly, and now is very, very late," in reversing itself
and cutting borrowing costs only modestly so far, Trump tweeted. "Too
bad, so much to gain on the upside!"
Earlier on Wednesday, White House trade adviser Peter Navarro told Fox
Business Network the U.S. central bank should cut rates by half a
percentage point "as soon as possible," an action he claimed would lead
"to 30,000 on the Dow."
A cut of that magnitude would typically be associated with serious
economic risk, not an economy with record low unemployment and ongoing
growth.
As it stood, major U.S. stock indices slumped by around 3% by
Wednesday's close with the blue chip Dow Jones Industrial Average
suffering its largest percentage loss of the year. Bond investors pushed
the yield on the 30-year Treasury bond to a record low.
Causing even more concern: The yield on the 2-year Treasury note briefly
went above the yield on the 10-year Treasury note, the sort of
"inversion" that, when it proves durable, has preceded prior U.S.
recessions.
Trump himself took note of the development, blasting the Fed chair he
appointed - Jerome Powell - as "clueless" in a tweet citing the "CRAZY
INVERTED YIELD CURVE."
FROM AS GOOD AS IT GETS TO GLOOMY
It was perhaps the most dramatic bit of evidence yet of just how the
landscape for the Fed has changed over the past few months, from one
that Powell deemed "remarkably positive" as of last October, to one of
rising risks for the United States' record-setting, decade-long
expansion.
As of last fall, the Fed thought the economy, fueled by the Trump
administration's massive $1.5 trillion tax cut package and spending
plans, would grow strongly enough to justify steadily higher rates.
At that point the threat of a recession seemed distant unless some sort
of outside event intervened to throw the economy off course - something
like the collapse of the dot-com stock market bubble ahead of the brief
2001 recession, or the implosion of the U.S. housing and credit markets
ahead of the more serious 2007-2009 Great Recession.
Yet, as Trump's trade rhetoric and his imposition of tariffs on trading
partners ratcheted up this year, particularly since May, investors have
acted as if a breaking point had been reached.
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U.S. President Donald
Trump talks to reporters as he boards Air Force One for travel to
Pennsylvania from Morristown Municipal Airport in Morristown, New
Jersey, U.S. August 13, 2019. REUTERS/Jonathan Ernst
Global trade flows have dropped. Economic growth in Germany, a bellwether
economy of sorts given its reliance on exports, contracted in the second
quarter. Data also showed industrial output in China fell to more than a
17-year-low in July. Indices of uncertainty also have spiked.
If Fed policy suddenly seemed out of step, it was perhaps inevitable given the
difficulty of keeping up with Trump's whipsaw approach to trade policy, and the
growing sense that the fallout may be deeper and longer lasting than expected.
"The challenge is that Trump's trade policy has proven so erratic that you
cannot relieve the sense of uncertainty," as firms adjust to what may be a
years-long rearrangement of global supply chains and cost structures, said Tim
Duy, an economics professor at the University of Oregon. "So the question
becomes is policy going to be easing enough ... or remain so tight that the
economy remains vulnerable?"
Investors in federal funds futures contracts are currently pricing in a
quarter-point rate cut at each of the Fed's remaining three policy meetings in
2019. That would take the benchmark fed funds rate to a range of between 1.25%
and 1.50%.
Along with the rate cut at the last Fed meeting in July, it would also mean the
U.S. central bank will have used up almost half the rate-cut "ammunition"
assembled during a slow-moving, and ultimately truncated series of rate
increases begun in 2015.
For Trump, who is hoping to make the economy a central part of his case for his
2020 re-election campaign, further rate cuts could not come fast enough. He has
been berating the Fed for its rate increases for more than a year - since even
before his trade rift with China morphed from being considered an economic
annoyance to a larger and potentially durable risk.
AHEAD OF CURVE?
Compared to the prior two recessions, the Fed may actually be ahead of the
curve.
In both the 2001 and 2007 downturns, the Fed raised rates even after the yield
curve inverted and did not cut until just a few months before the start of
recession about a year later.
In the current case, it signaled a policy shift in January, when it removed the
expectation of further rate hikes from the table, and then cut rates two weeks
before Wednesday's yield curve inversion.
Whether that proves adequate is another matter.
In an interview scheduled to air on Fox Business Network on Friday, former Fed
chief Janet Yellen said she felt the U.S. economy remained "strong enough" to
avoid a downturn, but "the odds have clearly risen and they are higher than I'm
frankly comfortable with."
(Reporting by Susan Heavey, Tim Ahmann and Howard Schneider; Editing by Chizu
Nomiyama, Paul Simao)
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