The Donald Vs. Powell – When the Federal Reserve Is Politicized, Markets Worry

The Federal Reserve, as expected, lowered interest rates by 25bp to a range of 2% to 2.25%. One thing is emerging from Jay Powell, Fed’s Chair, and his way of conducting monetary policy – he doesn’t like to surprise the markets or go back on any policy message that he has already iterated weeks or sometimes months before.

Leading up to the latest rate cut decision, Powell has already laid the groundwork weeks ago – with the strongest message was delivered when he testified before the Congress on July 10-11. Despite the robust economic reports that came out leading to the latest monetary policy decision (e.g., GDP, retail sales, and non-farm payroll), Powell didn’t back off from lowering rates – which somewhat puts into question the Fed’s commitment to be data-dependent. The decision was rationalized by looming trade tensions, low inflation, weak business investment and manufacturing, and slower global economic growth. These are reasonable factors to cut rates for insurance purposes. However, they also appear to open the door to political manipulation by President Trump as he escalates the trade war by imposing 10% tariffs on $300 billion goods imported from China starting September 1st.

Several people have speculated that the latest round of tariffs on China is aimed at forcing Powell’s hand to cut rates further. Once rates are down, Trump could back off from his trade war rhetoric or at the very least deescalate it to score more points with voters and boost equities. Despite my disdain from conspiracy theories, regardless of their appeal, it’s hard not to make this connection given its timing. But even if Trump didn’t mean to do so, he’s actions could still, down the line, force the Fed to slash rates due to an escalating trade war.

Powell is aware all of this and isn’t likely to change the Fed’s policy because of another round of tariffs. However, if the mounting uncertainties were to lead to further weakness in business investment and even slower global growth, then Powell is likely to act and slash rates.

Will a 50bp or 75bp cut be enough to provide insurance against a possible recession? Perhaps, mainly as the consumer remains robust, and as the government keeps stimulating the economy by expanding its Federal deficit, which should pass 1 trillion dollars this year. But the main issues Powell pointed out for reducing interest rates in July – business investment and manufacturing – aren’t likely to ameliorate because of lower rates. Their weakness stems from uncertainties regarding global economic growth and trade tensions.

For now, we are left with a Federal Reserve that is becoming, unintentionally, more politicized, as the President escalates the trade war and forces, intentionally or not, the Fed to slash rates. Moreover, even Powell’s latest press conference seems to create more confusion than clarity, especially as he doesn’t know what the Fed will do next. Put together, the Federal Reserve could start to lose some of its credibility, which will make its job harder to calm markets if and when the next recession arrives.   

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