Trump vs. the Fed: stimulus and growth

November 2019 | FEATURE | ECONOMIC TRENDS

Financier Worldwide Magazine

November 2019 Issue

The underlying health of the US economy has been a source of increasing speculation in recent months – conjecture heightened by president Trump’s spat with the Federal Reserve over monetary policy, with interest rates a particular bone of contention.

On the one hand, the cut in interest rates made by the Fed in July and September 2019 – the first such reductions since 2008 – is a response to, as outlined by Fed chairman Jerome Powell, signs of a global economic slowdown, the ongoing US conflict with China over trade rules and a desire to boost low inflation rates.

On the other, president Trump wants more aggressive stimulus measures – such as lowering interest rates by a full percentage point rather than the Fed’s actual 0.25 percent reductions in both July and September – and has suggested that the US economy is being “handcuffed” by the US central bank’s monetary policy.

“President Trump believes that the Fed must make ‘bigger and faster’ interest rate cuts and is ‘too proud to admit their mistake’ of raising interest rates too aggressively over the past couple of years,” says James Knightley, chief international economist at ING. “The president’s view is being driven by a belief the Federal Reserve should do more to support the economy as Trump seeks to extract trade concessions from China, but he is also likely to have been irked by other central banks around the world easing interest rates by more than expected.”

In the view of Nick Wall, portfolio manager at Merian Global Investors, the action taken by the Fed is the natural antidote to a slowing global economy. “US economic outperformance, aided by the Trump stimulus and divergent monetary policy vis-à-vis the rest of the world, has led to an exceptionally strong dollar,” he explains. “This hurt growth in the rest of the world given the high amount of liabilities in the reserve currency.

“Alongside the tariffs disrupting global value chains, these large dollar liabilities have killed global capital expenditure (CAPEX) and are tipping global manufacturing into recession,” he continues. “Global linkages through multinationals and financial markets mean this is spilling over to the US.”

Cut and consequences

While the Fed’s decision to cut interest rates by a quarter percentage point for the second time is a bid to “keep the economy strong", according to Mr Powell, there was discord over the decision. Moreover, pressure on the central bank – especially from president Trump – to do more to support the economy remains, particularly with yield curve inversion pressures indicating that a severe economic downturn, perhaps even a recession, could be on the way.

“Although the US economy is in better shape than other developed markets, many commentators foresee yet another interest rate cut, as concerns grow over a global slowdown.”

“The ever flattening yield curve is adding to a sense of nervousness,” asserts Mr Knightley. “All nine recessions since 1955 were preceded by an inverted yield curve. However, there have been false signals before and we have to recognise there are factors in play that are depressing longer US dated yields and thereby perhaps overhyping the threat of a recession.”

Forthcoming downturn or recession aside, Mr Wall favours more aggressive stimulus. “By only cutting interest rates in small steps the Fed risks further dollar strength, tightening financial conditions and rendering the lower interest rate inconsequential,” he says. “Global growth will be kept in the doldrums as businesses cut back investment, which eventually leads to lost jobs.

“However, deeper cuts grease the wheels of global trade via a weaker dollar, and the market would price reflation and growth convergence again,” he continues. “Fed policy is getting too tight for its own economy even without taking into account dire global growth.”

Cuts to come?

Although the US economy is in better shape than other developed markets, many commentators foresee yet another interest rate cut, as concerns grow over a global slowdown. On this point, Mr Powell has previously hedged his bets, stating that while there was likely to be more than one cut, as was borne out by the September reduction, there would not be a series.

“Markets will not get out of a secular stagnation mindset until the Fed eases aggressively, reducing the degree of policy divergence between itself and the rest of the world’s central banks, and as a result weakening the US dollar,” believes Mr Wall. “The recent devaluation of the renminbi puts even more onus on the US central bank to ease policy to get the dollar down. Yield curve, trade and the dollar should be the key metrics the Fed looks at, not lagging domestic data.”

According to Mr Knightley, a further interest rate cut by the Fed would be too cautious a move. “With other central banks easing aggressively, this risks exacerbating upside pressure on the US dollar,” he says. “This could further dampen growth and inflation and add to the pressure on the Fed to ease policy.

“President Trump wants to win re-election next year and recognises that a robust economy with rising asset prices is critical for that to happen,” he concludes. “However, in the Federal Reserve, he has a central bank that seems reluctant to offer the support to the economy he feels is necessary.”

Fraser Tennant