The President Rails, The Chairman Dons Ear Muffs

Who says Americans are deeply divided on all issues? Not true. Both the President and the hard left, including a new group, Employ America, agree that the Federal Reserve should cut interest rates, a lot and soon. But the Fed, led by chairman Jay Powell is not ready, at least not yet, to lower rates.

The Fed will have an opportunity to make its views known when it holds its policy meeting on tomorrow and Wednesday. It is likely to disappoint the odd team of Trump and left-wing Democrats. Not because the data do not support those who are pressing the Bank to cut rates. Rather, its policymakers know that the future course of the economy very much depends on whether the Presidents of the United States and the Peoples Republic of China can agree a truce (peace is beyond their grasp) in their tit-for-tat tariff war when they meet in Osaka at the G-20 summit later this month. A continuation of the war would add to the headwinds slowing growth and favor a rate cut; a truce would eliminate one impediment to growth, and be entered on the stand-pat side of the ledger.

Powell has still another political reason for resisting pressure for an immediate rate cut, especially now that the Bank is in the midst of a year-long review of its established policies. The economy has grown in the past twelve months at an annual rate in excess of 3%. The unemployment rate, at 3.6%, is at its lowest level in 50 years. The number of job openings exceeds the number of job seekers by a record 1.6 million. The ailing housing market received a shot in the arm when mortgage rates dipped below 4% last week. And on Friday the Commerce Department reported not only that retail sales rose a healthy 0.5% in May, but revised earlier data upwards. It would almost be, well, unseemly for a central bank to lower rates in these circumstances rather than maintain its patient stance until it can satisfy itself that growth is not merely slowing from a red-hot 3% rate to a more sustainable, acceptable pace of around 2.5%. Traders assign a probability of 24% to a rate cut this week; I would put it closer to zero.

So much for the facts that describe the “political” in political economy. The economic facts do seem to favor a reduction in interest rates. All signs are that the economy has slowed from the 3.2% rate (preliminary estimate) it clocked in at during the first quarter to about half that rate. The miraculous American job-creating machine went from a monthly average of 200,000-plus per month to 75,000 in May. The manufacturing sector has lost steam. The boost from the Trump tax cut is fading. And the Trump trademark — uncertainty — is starting to have a negative impact on the confidence of CEOs and Chief Financial Officers. The Business Roundtable says CEO confidence is at its lowest level in over two years, while a survey by Duke’s business school found that 69% of CFOs believe a recession will take hold by the end of next year. These are the people who, believing their forecasts, make them come true by cutting investment spending.

In addition, although wages have begun to rise, inflation by many (although not all measures) remains below the Fed’s long-run target of 2%; economists at Goldman Sachs estimate that the Fed’s preferred inflation measure rose a mere 1.4% in May. Meaning that a rate cut is unlikely to trigger inflation at a rate higher than the Fed’s target. And if prices do shoot up after a rate cut, the Fed monetary policy gurus have a fall-back position: it is acceptable for the inflation rate to exceed 2% for a while because it has been below that figure for so long. Less kindly put: our forecasts were wrong for so long in one direction, that it is okay for us to be wrong for a while in the other.

After the G20 meeting all eyes will be on the Fed’s July meeting. My guess is that by then Trump and Xi will have found a way to paper over their differences in a communiqué that allows for what I have called a truce in the trade war. But not peace in our time. Trump is demanding a reversion to the agreed negotiating draft that a horrified XI redacted beyond recognition when it was presented to him. Xi can concede that much ground only if he is willing to abandon his plans for making China great again. Which he isn’t.

Instead, he has called to active duty Yu Jianhua, who has been in semi-retirement as China’s ambassador to the UN in Geneva, the sort of cushy assignment handed out to communist bureaucrats who have served the regime well and are en route to full retirement. Yu is to head the trade negotiating team. He has 28 years of experience leading trade talks with the WTO and American officials, and will not make the concessions that China’s inexperienced, and worse from Xi’s point of view, reformist team of lawyers and economists made before his veto and the subsequent breakdown in talks. We are on a long march to a new world of incompatible trading orders and high tariffs. Powell knows that, and with interest rates already at about zero when inflation is factored in, he would prefer to save some of his rate-cut ammunition to fire off should the economy teeter on the brink of, or dip into recession.

Unfortunately for him, he might be required to expend it now rather than hold it in reserve. Traders are assigning an 85% probability to an interest rate reduction in July. And most expect further cuts to follow later in the year. The President will fume that the cuts are too small, and demand more of them.

Trump wants Powell, his appointee, gone, but his lawyers say he can’t be fired: the ever-gracious President told the Fed chairman, “I am stuck with you”. But Powell might not be stuck with Trump. The President trails six of his possible 2020 opponents in the polls, and economists are predicting a recession close to voting day in 2020, an event that would make renewal of Trump’s lease on the White house unlikely.

Since Powell’s term does not expire until 2022, the chairman, who seems to be following Alan Greenspan’s advice to don ear muffs, might be rid of this meddlesome President before the President is rid of this independent chairman.