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Federal Reserve A Bigger Headwind To Trump's Economy Than China

This article is more than 5 years old.

Blame Jerome Powell for this week's roller coaster ride on the Dow.  Every single time the Fed chairman speaks about interest rates, he has investors from sea to shining sea hitting the sell button. Powell is a bigger headwind to Trump's economy than China. No wonder Trump has come out swinging against Powell, his own pick to lead the Federal Reserve.

On Friday, J.P. Morgan CEO Jaime Dimon told investors that the biggest headwinds were the Fed first, and then China a distant second. "The economy is growing. Rates are going up. Most of us consider this a healthy neutralization. I expect rates will continue to go up," he said, predicting 4%.  That may be a bit conservative. Four percent is not priced into the market at the moment. The 10 year Treasury has gone down and is now at 3.16%.

Raising rates in a growing economy is akin to "stacking the wood", some economists believe. It's preparing for colder winters and gives the Fed a chance to cut rates deeper when the business cycle turns recessionary. The Fed cuts rate by around 500 basis points on average during a recession. If the U.S. economy was in a recession now, the Fed would have less room to cut, threatening negative yield for the first time.

But to investors who like cheap money and a booming economy to go along with it, stacking the wood is more like putting a patient in recovery back into intensive care just in case they get sick again. Water cooler chatter on Wall Street has Powell out by March if he keeps putting the brakes on the U.S. economy.

Even Paul Krugman recently went out on a limb today. In a Twitter rant, The New York Times columnist and MIT economist who once predicted a recession if Trump won the election said that Trump had a point: Powell was too hawkish.

Danny Blanchflower, a professor at Dartmouth College and a former external member for the Bank of England's monetary policy committee thinks the Fed is the wet blanket here, too.

In other words, even anti-Trump types are supporting Trump who called the Fed "out of control" this week, following Wednesday's 600 point drop in the Dow.

Anyone who wants to buy a house or invest in a new business is going to think twice if they feel the Fed is going to raise rates higher than expected. And scaring the market in the meantime. Another rate hike is expected in December and then two more in 2019. The rhetoric on the hawkish side of the Federal Reserve has the overnight lending rate going 50 basis points above the median long-term neutral rate of 3%, a rate which they have called "slightly restrictive."

Trump wants no restrictions.

Rates usually rise to reduce inflation. But where is all this inflation?

On Oct. 11, the Consumer Price Index rose 0.1% in September, a tenth of a percentage point less than expected. This follows a 0.2% rise the month prior. Year-over-year, headline consumer prices rose 2.3% in September, less than the 2.4% increase expected, marking a seven-month low.  There is no real inflationary threat on the horizon. Moreover, automation and advances in technology are keeping production costs lower, meaning prices are mostly in-check.

"Each and every month, market commentators will find a reason for why the inflation print has deviated from their expectations, but while this can be a creative exercise, it often tells us little about the cyclical trend in aggregate price change," says Rick Rieder, fund manager for the BlackRock Strategic Income Opportunities (BSIIX), BlackRock Total Return (MAHQX), and BlackRock Strategic Global Bond (MAWIX) funds. BlackRock manages $1.88 trillion in fixed income funds.

"The fact is that inflation continues to firm, and came in modestly below expectations again," Rieder says.  "The new economy evolving today is replete with technology-driven goods-sector disinflation and that will mean that the neutral rate of interest, and the desire to go much above it, will likely be muted, despite recent comments from the Fed Chair."

If that is the consensus view, it explains why the sells off heavily when Powell diverges from this view.

"Cooling price gains should be enough to calm fears of an overly-aggressive Fed," thinks Stifel Chief Economist Lindsey Piegza. "The market isn’t as convinced that the (Fed Open Markets) Committee will give the warranted attention to the recent pullback in inflation and remain on a 'gradual' path."

Regarding labor markets, wages have improved at a decent pace but do not appear to be translating into price increases at a general level. Nor has the trade war with China meant increases in prices to the point where inflation is a concern. Wage gains do not mean inflation necessarily unless corporate pricing power shifts meaningfully higher.

A Fed that wants cheaper labor costs is a Fed working against the majority of the populous. Who doesn't want to earn more money from their labor? Democrats? Republican? A few hundred Green party voters?

It is possible that the increasing price of labor compresses corporate margins. Investors will get a better sense of this in earnings calls happening now. Citigroup reported better-than-expected earnings for the third quarter on Friday thanks to lower corporate taxes. PepsiCo beat their earnings estimates this month, as well.

The Fed's mandate is to contain inflation, keep unemployment low and maintain economic growth.

"We have that. What's the argument for upsetting the equilibrium that we have achieved?" asks Vladimir Signorelli, head of Bretton Woods Research in Long Valley, NJ. "Back in 2004, Alan Greenspan advanced the notion of a neutral rate, saying we couldn't define it precisely, but we would know we were there when we got there. It took 15 consecutive rate hikes and they never got to neutral, but they destroyed the housing market and brought on one of the biggest recessions this century."

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