With global markets flashing concern about the fallout from the U.S.-China trade war and the near-term strength of the American economy, U.S. President Donald Trump on Wednesday targeted Federal Reserve policy as the culprit for recent market turmoil.
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, 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.”
As it stood, the Dow Jones Industrial Average was down more than 2.4% on Wednesday along with other major U.S. stock indices, and bond investors had pushed some U.S. Treasury yields to record lows.
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.
It was perhaps the most dramatic bit of evidence yet of just how the U.S. economic outlook has changed over the past 12 months, from one of clear sailing and continued growth, to one of rising risks for a decade-long expansion.
It typically takes some sort of shock to throw the U.S. economy off course – the collapse of the dot-com stock market bubble ahead of the brief 2001 recession; and the implosion of the U.S. housing and credit markets ahead of the more serious 2007-2009 Great Recession.
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 that shock may have arrived.
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.
Is The Fed responsible?
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“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.
As of September last year, the U.S. central bank had a relatively rosy outlook for the economy, expecting that the stimulus from the Trump administration’s massive $1.5 trillion tax cut package and spending in 2018 would sustain growth and justify steadily higher interest rates.
The stimulus faded faster than expected, leaving even some Fed officials to feel that borrowing costs had been lifted too high.
For Trump, who is hoping to make the economy a central part of his case for his 2020 re-election campaign, further rate cuts couldn’t 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.”
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