Trade chaos

Why Trump’s trade chaos may force Fed to cut rates

Trump's battles have fueled concern that the central bank may have to come to the rescue of the economy.

By VICTORIA GUIDA

For months, President Donald Trump has pressed the Federal Reserve to cut interest rates to make the economy take off like a “rocket ship.” But after his latest move to inflame trade tensions, the Fed might need to lower rates just to stave off a dramatic slowdown.

As Fed officials begin a landmark two-day conference on Tuesday in Chicago to reconsider their approach to fighting inflation, Trump's battles with Mexico, China and every other major U.S. trading partner have fueled concern that the central bank may have to come to the rescue of the economy.

Some of the country's top economic forecasters have raised the specter of a Fed rate cut this year in the wake of Trump's tweet last Thursday threatening to raise tariffs on Mexico over immigration, which sent stocks tumbling the next day. And markets are predicting greater than 50 percent odds that a rate reduction will come as early as July.

“The administration doesn't seem to care how disruptive its actions are," said Lou Crandall, chief economist at Wrightson ICAP, an independent research firm. Trump's actions, he said, are creating "huge C-suite uncertainties. Investment-freezing, employment-chilling and growth-stifling uncertainties.”

The Fed's Chicago conference was in the works long before Trump began bashing the central bank over its policies. But in the wake of the increasing trade conflicts, markets will especially be watching for clues on what the Fed might do when Chairman Jerome Powell, who has been the main target of Trump's wrath, speaks on Tuesday at the event.

Trump's tweet on Mexico spooked investors in part because it threw the future of the renegotiated NAFTA deal into doubt and raised the possibility of retaliatory tariffs from the U.S.'s third-largest trading partner. That, plus ongoing quarrels with other trading partners, could imperil the economic expansion, which is set to become the longest in American history this July.

That would leave the Fed as the president’s best buffer to sustain the healthy economy — the most potent selling point for his reelection with voters beyond his base.

Prominent Fed watchers, including Michael Feroli, chief U.S. economist at JPMorgan, and Laurence Meyer, a former Fed governor, now expect a reduction in rates this year.

Trump’s Mexico tariff tweet “adds yet another trade-related headwind to the growth outlook,” Feroli said. “Even if a deal is quickly reached with Mexico, which seems plausible, the damage to business confidence could be lasting, with consequences that might still require a Fed response.”

St. Louis Fed President Jim Bullard, who gets a vote this year on rate policy actions, suggested in remarks Monday that a cut “may be warranted soon.”

Seth Carpenter, chief U.S. economist at Swiss bank UBS and a former Fed staffer, said the central bank would never lower rates for the purpose of making it easier for the president to fight trade wars, as Trump has explicitly suggested they do.

“On the other hand — an easily imaginable scenario is that the trade war escalates ... and it rattles markets, and it causes the real economy to slow down,” Carpenter said. The Fed would “absolutely take that into consideration” in its monetary policy decisions.

“So, they’re backing into doing what Trump wanted them to do,” he added. “But what else are they going to do if truly their objective is to maintain full employment and price stability?”

Heightening trade tensions adds to the Fed’s already uncertain outlook for the U.S. economy, amid slowing global growth and signals in the Treasury market that could portend a recession. Fed officials have repeatedly cited trade policy as a significant risk to the economy and have maintained a pause in rate changes while they watch how economic conditions unfold.

Fed Vice Chairman Richard Clarida last week said the central bank views the U.S. economy as being in “a very good place” and expects inflation over time to move up toward the Fed's 2 percent target, suggesting no imminent need for a rate move in either direction.

But he also indicated the central bank is willing to be flexible if that outlook changes, implicitly hinting at the possibility of rate cuts if “global economic and financial developments present a material downside risk to our baseline outlook.”