Trump and the stock market are spooking Powell into making this rookie mistake
By all accounts, the U.S. economy is growing robustly, with very low unemployment and very low inflation. The Dow Jones Industrial AverageDJIA, +0.29% and S&P 500 indexSPX, +0.45% are near record levels and interest rates are extremely low. It’s what they used to call a Goldilocks economy, with nothing too hot or too cold and everything just right.
So, of course, the Federal Reserve is going to cut short-term interest rates in three weeks as insurance against the possibility — however remote — that the economy might soon collapse because of slowing global growth, in part attributable to Donald Trump’s trade war.
It’s a rookie mistake by Fed Chair Jerome Powell, who’s been bullied by President Trump and financial markets into pumping more liquidity into an economy that already has plenty. And don’t think for a second that Powell’s tormentors will be satisfied with just one quarter-point cut.
Instead of maintaining a data-dependent stance that would let the evolving state of the economy inform their decisions, the Fed has opted to fly by the seat of its pants, to let gut feelings dominate reason.
Instead of the Fed taking away the punch bowl so the party doesn’t get out of hand, Powell is volunteering to go on a run to the store even though the liquor cabinet is fully stocked.
It’s happy hour at the Powell Put Saloon.
If lack of confidence in the future is the problem, it does no good to see the Federal Reserve in full panic mode. If trade wars are what’s causing the uncertainty, the only solution is to resolve that uncertainty, not paper over it with cheap money. Neither the price of credit nor the access to credit is restraining the economy, so how does a rate cut help?
The closest parallel to this upcoming rate cut are the emergency cuts in 1998, when the Russians were defaulting and the Long-Term Capital Management fund collapsed. But the issue then wasn’t uncertainty per se, but actual lack of liquidity. Fed Chairman Alan Greenspan responded with a fire hose of liquidity that, traders should remember, fueled the final ascent of the Nasdaq bubble.
Today, as then, the economy is growing above trend. But there are no liquidity concerns now.
What’s troubling business leaders is a binary future: One with relatively free trade around the globe, and the other with protectionist walls everywhere. That issue will not be resolved by the Fed, but by Trump, the Chinese and other global leaders.
Cutting rates doesn’t help that process. A rate cut at this point only emboldens Trump and those leaders to adopt even harder lines. They know Powell has their back if they create even more uncertainty.
What’s more, the economic outlook has brightened since the June meeting.
The global headwinds receded slightly with the tariff truce at the G-20 summit. The tail risk of a U.S. recession also lessened, with a rebound in hiring, better capital spending numbers, a brighter outlook for consumer spending, and a rebound in trade flows reflecting strong domestic demand, which seems to have rebounded nicely in the second quarter.
One can well imagine that, in a parallel universe, Powell was telling Congress on Wednesday that the outlook had improved since June and that a rate cut at the end of the month was unlikely. That testimony fits the facts just as well.
Recall that Fed officials at their June meeting concluded, nearly unanimously, that no rate cuts were necessary. A slight majority of the Federal Open Market Committee participants (those who vote this year as well as those who will rotate into voting positions) thought no rate cuts would be necessary this year.
Fed officials were in agreement in June that the economy would likely continue to grow above its long-term trend through the end of 2020, that the unemployment rate would remain below its long-term level for the foreseeable future, and that inflation would be near to their 2% target.
Not one member thought growth would go below 1.5%. Not one thought unemployment would go above 4%. Not one thought inflation would drift further away from the target.
Since then, few Fed officials have argued forcefully for rate cuts. Even dovish James Bullard spoke out against an aggressive 50 basis-point move. None of the board governors have been beating the drums for a cut. Among the regional bank presidents, at least half have argued for a continuation of the wait-and-see policy.
All that said, Powell will deliver the rate cut demanded by Trump and the markets. But it will only be by bullying policy makers such as Randal Quarles, Richard Clarida, Lael Brainard and John Williams — none of which have spoken about policy recently but are assumed will support Powell — into going against their better judgment that the Fed should hold its fire and see which way the U.S. economy evolves.
Source: Read Full Article