Disrupt Fed outlook for economy

Trump’s trade wars threaten to disrupt Fed outlook for economy

By VICTORIA GUIDA

The Federal Reserve is poised to raise interest rates Wednesday for the third time this year as the economy powers ahead, but beyond that the central bank’s outlook has been thrown into confusion by President Donald Trump’s trade battles.

For months, top Fed officials such as Chairman Jerome Powell have downplayed the impact of Trump's escalating trade disputes on the broader economy.

But now, the president has imposed tariffs on $200 billion more in Chinese goods and threatened to penalize another $267 billion — moves that will essentially cover all U.S. imports from the world's second-largest economy. Beijing has responded with duties of its own on billions of dollars in U.S. goods.

That has stoked concern that a prolonged and expanding trade fight could slow growth while also pushing up prices.

“This is not just a threat,” said Lindsey Piegza, chief economist at Stifel Fixed Income. “This is going to change the pathway for the U.S. economy.”

The U.S. is also threatening to move forward with a new NAFTA deal that excludes Canada if negotiations with Ottawa are unsuccessful — Sept. 30 is the current informal deadline. And the Trump administration has already slapped global tariffs on washing machines, solar products, steel and aluminum.

Even more duties may loom on automotive imports to the U.S., an event that analysts speculate could finally spook financial markets, which have largely shrugged off Trump’s trade skirmishes so far.

It’s still too early to predict the ultimate impact of U.S. trade policies, but they are leading some businesses to hold off on investment in factories, equipment and workers. And if major companies begin to reorganize their global supply chains, it could reduce economic output.

“Trade is the single biggest risk factor in the growth outlook,” said Lou Crandall, an economist at Wrightson ICAP. “It’s this very unpredictable factor that isn’t governed by slow-moving cyclical events, but by fast-moving political events.”

Central bank officials laid out their worries in the minutes of the last meeting, when they pointed to trade disagreements "as an important source of uncertainty and risks.”

They said a broad and prolonged dispute would adversely affect "business sentiment, investment spending, and employment,” according to the minutes. Other potential risks: reduced purchasing power for U.S. consumers and hits to productivity.

The Fed has projected one more interest rate hike this year after this week and three more next year, a gradual but steady effort to return to a more normal level after roughly a decade of keeping rates near zero. It's also shrinking its multitrillion-dollar holdings of Treasuries and bundled mortgages that it bought to support the economy in the wake of the financial crisis.

The central bank faces a delicate balancing act in supporting sustained economic growth without accelerating inflation, as the near-record-long expansion continues. New tax cuts and increased government spending are speeding short-term growth, but wage growth is still only moving at a modest rate.

Earlier this year, it wasn’t clear whether the president would follow through on some of his trade-related threats. Now that he has taken multiple concrete actions, the Fed “is going to start doing some very in-depth analysis and taking the Trump administration at face value,” Stifel’s Piegza said.

His trade policies are already crimping business optimism, according to a new survey of some of the nation’s top CEOs, although confidence is still quite high. Nearly two-thirds of executives said they expect to reduce planned capital investments over the next six months because of new and looming tariffs.

“The negative effects from trade policies are being masked by overwhelmingly positive effects from good tax and regulatory policy,” said Josh Bolten, president and CEO of the Business Roundtable. The survey was conducted before the most recent round of tariffs on China took effect.

Almost all the Roundtable member CEOs “have pretty deep anxiety about the use of tariffs as a principal tool of U.S. trade policy,” Bolten said, adding that it hurts their supply chains, product prices and competitiveness abroad.

But the results of the quarterly survey are still the fifth-highest reading in its 16-year history.

“I haven’t seen anything yet that objectively says this is going to have a significant dampening effect on domestic economic activity, although there are lots of reasons to fear that it could,” Crandall said.

If trade disputes do lead to slower growth, the Fed could respond with a corresponding decrease in rate hikes. But its path could get trickier if the tariffs push up prices enough that consumers start to expect inflation to grow much more quickly than the Fed’s 2 percent target.

“You could imagine a scenario where we’re all going along just fine … but then suddenly there’s this tariff, … and companies that were holding off on price increases see this as an opportunity to raise prices, and consumers just kind of accept it,” said Tim Duy, an economics professor at the University of Oregon.

“Then [the Fed] is going to say, ‘Wait a second, maybe we do need to be more aggressive,’” he added.

Duy said the amount of trade affected so far is a small portion of economic activity, and it might not have a huge impact on inflation — particularly since not all the increased costs borne by producers will be passed along to consumers.

Regardless, “it’s a whole bunch of noise” that the Fed will have to sort through, Duy said.