Save the economy

The Fed’s real message: Save the economy from Trump

The central bank is expected to cut rates this week in part to offset President Donald Trump’s trade war.

By BEN WHITE and VICTORIA GUIDA

In the case of Donald Trump vs. the U.S. Federal Reserve, the president of the United States is likely to secure a winning verdict this week.

Central bank officials are expected to cut interest rates for the first time since the global financial crisis not because Trump demanded it. Instead, they will move in part because the president’s bruising trade policy has helped fuel a global manufacturing slowdown and injected deep uncertainty into executive suites around the world.

Fed Chairman Jerome Powell won’t directly say it directly after his meetings Tuesday and Wednesday. But the central bank will reverse course at least in part to save the Trump economy from Trump.

“There is just no question that Powell has been 'Trumped' here,” said Ed Yardeni, president and chief investment strategist of Yardeni Research Inc. “Just read Powell’s comments during his recent congressional testimony and trade comes up eight times in the context of weighing on the global economy. All Trump had to do was keep up geopolitical trade uncertainty for a while and he’d get the Fed to cut rates.”

Trump continued to hammer away at the Fed in public comments and tweets on Monday, arguing that a series of rate hikes over the last three years slowed what would otherwise be a much faster economy.

“The Fed ‘raised’ way too early and way too much,” Trump tweeted. “Their quantitative tightening was another big mistake. While our Country is doing very well, the potential wealth creation that was missed, especially when measured against our debt, is staggering.”

But the data does not really support his argument. Interest rates, adjusted for inflation, remain historically low. And consumer spending, which is where higher rates might slow things down, remains the dominant engine of growth. It is on the corporate investment side — where the 2017 tax cut was supposed to unleash a wave of growth — where conditions have stalled.

The U.S. GDP report out last week showed growth slowing to a 2.1 percent pace in the second quarter from 3.1 percent in the first. Most of the gains came from consumer spending, which rose a strong 4.3 percent. Business investment declined by 0.6 percent, the first such drop since the first quarter of 2016. Exports, a key metric for Trump’s promise to reinvigorate American manufacturing, plunged by 5.2 percent and imports rose, increasing the trade deficit.

Trump administration officials say the president is taking a longer-term view of trade relationships and hopes to eventually win concessions from China on important issues including forced technology transfer and intellectual property theft.

They also contend the Fed went too far in rate hikes. National Economic Council Director Larry Kudlow said in a recent interview that the Fed should make an "insurance" cut in rates to prevent any slowdown and give the tax cuts more time to work.

Meanwhile, signs of a declining manufacturing sector in the U.S. and abroad continue to pile up. The J.P. Morgan Global Manufacturing Purchasing Managers Index, or PMI, reading recently moved into contraction territory for the first time since 2012. Of the 30 nations issuing a PMI report for June, 18 registered a contraction including China, Japan, the UK and Germany.

In the United States, the Institute for Supply Management index for manufacturing dropped for a third straight month in June to 51.7, still indicating expansion but at the weakest level since October 2016, before the trade battles began. Fresh manufacturing data for the U.S. and China will come out later this week.

Job growth in manufacturing companies has also slowed from 22,000 new jobs per month last year to 8,000 per month this year. The Fed said earlier this month that U.S. industrial production was technically in recession, meaning two straight quarters of contraction.

Powell on multiple occasions has cited concerns that trade fights were hurting growth and denting confidence, while being careful not to antagonize Trump directly.

“What we’re seeing is business fixed investment … it’s really slowed down now,” Powell said in congressional testimony earlier this month. “There’s no perfect way to identify these things, but we do connect that to trade policy uncertainty and also uncertainty on global growth, weaker manufacturing around the world.”

The Fed has made clear that trade tensions loom large in its worries about risks to the economy. Company investments in long-term projects like factories and technology picked up during the first half of 2018 in the wake of corporate tax cuts, but those investments have faded much faster than expected.

The central bank’s business contacts tell the Fed they aren’t sure where to put their money because they’re not sure where tariffs might show up next.

“If you’re a manufacturing company in our economy, of any size, chances are pretty good that your supply chain goes across national borders,” Powell said in his testimony. “That supply chain is really part of how you do business, and you just assume that it’s working and you can focus on your clients. When your supply chain is called into question — we hear this a lot from businesses — when it’s called into question, you pull back.”

Powell said trade uncertainty “spiked” in May. Though he didn’t explain why, that coincides with the president’s threat to put tariffs on Mexico over the ongoing migration crisis. Trump's tweet on Mexico spooked investors 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.

The central bank has also quantified the direct impacts of the trade battles, though those are less a factor in the growth picture. In its semiannual monetary policy report to Congress earlier this month, the central bank estimated that new tariffs might have lowered U.S. imports by roughly $70 billion.

The impact of Trump’s trade wars are starting to weighing on some corporate earnings like those of equipment maker Caterpillar, Apple and chip-maker Nvidia, among others. Economists fear it could get worse.

“Trump’s trade policies are starting to show up in corporate balance sheets,” said Joseph Brusuelas, chief economist at consulting firm RSM. “In the third quarter you’d expect to see profit-margin compression across a wider array of earnings reports and the consumer will feel it, which could cause a pullback in consumption. That’s where the problem is for the White House.”

Businesses are also becoming less bullish about future growth, in part because they are uncertain how they will be impacted by tariff policy. The National Association for Business Economics on Monday reported that in its latest survey, members said they believed growth will slow and corporate sales and profits will decline this year.

Inside the survey, 56 percent of goods-producing firms said they had altered supply chains in response to trade policy and 38 percent said they’d delayed investments.

The Fed will likely step into this slowdown scenario on Wednesday with a rate cut of at least a quarter point and perhaps as much as a half a point. Trump already predicted on Monday that whatever it does will not be enough for him.

Economists, meanwhile, question whether a Fed rate cut will do very much to alter the economic picture. Part of the Fed’s rationale for a cut is that the inflation central banks feared would arrive with the jobless rate at historic lows has not arrived. In that sense, the pivot to cuts will be a big win for progressives who have long argued for Powell and the central bank to allow the economy to run hotter.

But with borrowing costs still very low, it’s not likely to change underlying corporate behavior, which may only respond to a more certain policy environment.

“The biggest risk to growth for the economy is the uncertainty as to where economic policy is headed,” said Steven Ricchiuto, chief U.S. economist at Mizuho Securities USA. “And it’s not as if the Fed can fix some of these problems related to uncertainty caused by the administration and these global-related issues.”

There is also some fear that the Fed cutting interest rates will keep investors searching for investments that offer a higher rate of return. These so called “high yield” investments include lower-grade corporate debt and high-risk loans that have risen in volume in recent years and could create significant problems if a sharper slowdown forces defaults.

“The lack of credit is not the problem in the global economy,” Yardeni said. “Central bankers are convinced they can fix problems, when in fact they can’t. And the reach for yield is starting to get borderline insane with the lack of covenants in bonds and loans. I’m starting to get a little feeling of deja vu all over again.”