Chaotic trade policy and tariff hikes can’t be undone by a simple Fed rate cut—here’s why markets need more than miracles.
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Behold, believers and non-believers. It is the season of miracles in all the world… except maybe in the markets…and politics. When the President decided recently to put a hold on the extreme, broad-based reciprocal tariffs, markets were pleased but probably not surprised. When the administration announced new restrictions on certain chip sales to China causing beleaguered chip giants AMD and NVIDIA to report revenue impairments, markets did not take the news lightly but were not completely surprised. The possibility of a re-look at the stiff tariffs on automakers? Surprised? How about firing the head of the central bank of the largest economy in the world whose currency and sovereign debt are the de facto benchmarks of safety the world over?
Really, none of it has been a surprise. The administration's chaotic rollout of trade policy has not only sent the equity markets into a tailspin but also wrought havoc on long-dated Treasuries and Dollar strength, sending fearful investors into gold in an end-of-days, safe-haven trade. What might be the solution to all this pandemonium? The Fed?
If the Fed cut rates, would it suddenly cause investors to regain confidence in US Treasuries? Would it make the administration's ambiguous trade policy more palatable to portfolio managers entrusted to protect their clients’ capital? Would it stave off capital flows into Bunds or JGBs in favor of Treasuries? Of course, not.
How about the markets? Would a rate cut re-awaken the now-deceased bull market? It may possibly give a temporary boost to markets by elevating investor confidence, but 25 basis points in short-term borrowing costs could hardly offset a literal 10% - 145% tax now being charged to US COMPANIES on imports. Nor would it help farmers who have sold less soybeans, poultry, and sorghum to China, nor the US whiskey makers whose products have been removed from Canadian stores. No. Any rate cutting can only give investors something to raise the spirits temporarily. A 25 basis-point Fed Funds cut in this environment would be the equivalent to holding on to a splintered piece of decking from the Titanic in the dark, rough seas of the North Atlantic. But yet the Fed, specifically Chair Powell has caught the ire of the President, causing a barrage of veiled and direct threats to be hurled his way since the Chair’s indifferent comments at the Economic Club of Chicago.
The President’s displeasure of Powell should be no surprise. It is well-known that the President has not appreciated his appointee’s fervent independence since his last Presidency. It is also well-known that the President favors low interest rates and a weak dollar. Interestingly, under normal circumstances, the two typically occur simultaneously. Unfortunately, we are currently not operating under normal circumstances. The Dollar is indeed weakening as a result of capital outflows. Now, there is no way to confirm the exact reason, but several large banks have confirmed that foreign investors are selling Treasuries in favor of foreign, sovereign debt which would certainly cause yields to rise and the Dollar to decline. One out of two 'ain't bad, I supposed, but unfortunately from unnatural causes.
Regardless of all these well-understood relationships, the President and some of his advisors have audibly rattled their sabers these past several days calling into not only the question of the legality of removing the Fed Chair, but also more importantly, the negative impact that a non-independent Fed could have on the strength of not only currency and sovereign debt, but also, possibly US stocks. What? You don’t think the world would shun US stocks? Did you know that many portfolio managers will simply not position Chinese equities out of fear that the Chinese Government will meddle with their investments–it is a well-known fact that they have.
Let’s take a quick step back and consider the Fed for a moment. What can and can’t the Federal Reserve do? The Fed is now making quite obvious, hawkish overtures under the guise of inflation fighting. It is well-known, and the Fed finally admits, that tariffs will have short-term inflationary impacts, and possibly long-term ones as well. However, tight monetary policy has no impact on the tariff-borne, margin compressing, effects that may cause companies to raise consumer prices! Moreover, the sticky inflation that persists in services, particularly healthcare, education, and housing cannot be squelched by tighter monetary policy. Even if tighter monetary conditions were warranted, it is important to note that the markets themselves, with declining stock and bond returns, are doing the good work of the Fed making consumption untenable for some. But really, if the Fed cannot tackle the type of inflation caused by tariffs, why would it push pause on rate cutting? That is a good question, and the only answers can be the following. Either the Fed believes it will need all the dry powder necessary if 💩 hits the fan with the economy, or the Fed is playing chicken with the President trying to force him to abandon his trade policy. The first is plausible and even practical, while the latter is… well dangerous. However, the benefit to a more dovish, in word and action, Fed could salve the stress in the markets and consumers who are losing confidence. So, some potential gain, albeit, likely temporary.
So, should the President pursue the firing of Powell? Would there be any downside to replacing Powell with a bent-knee, White House employee? Well, I think you know the answer to that. If we are intent on the dollar being brushed aside as the World’s reserve currency, it may be worth a shot. I mean, who doesn’t like lower interest rates?
Look, if we step back and look at the big picture, we may see things a bit differently. It is clear that the US needs to tackle unsavory trade practices by China and the threat of high tariffs has proven in the past to exact concessions. It is therefore reasonable to assume the President will ultimately negotiate and remove the current 145% tax rates. It is also clear that we would like to see more production take place on US soil, if at least for security reasons on strategic products. This can be accomplished but not likely by increasing taxes on US companies but rather by reducing taxes on US companies.
Finally, if the Administration continues its current path and finds a way to strip the independence of the Fed, we can count on the longer-maturity Treasury yields to continue to climb, something that the Administration would clearly not like to see. So, what does all this mean? Well, despite Powell’s and his FOMC committee members’ rhetoric-infused talk, it is likely that the Fed will ultimately cut interest rates in the second half of the year in order to preempt any slowdown in the labor market or at least turn up the dovish talk. It is also likely that the Administration will negotiate settlements with US trade partners and remove the current tariff regime before it has any material impact on US corporate earnings. Moreover, if Congress can manage to come up with an extension of the 2017 tax legislation as well as a meaningful corporate tax cut, AND the Administration could buffer some recent value destruction brought by DOJ and FTC actions against US companies, we could end up with some real miracles in the markets. Being able to benefit from all these miracles will take patience and continued focus on long-term goals. Please, be patient and stay focused on the long run.
THURSDAY’S MARKETS
Stocks had a mixed close on Thursday as worried traders headed home for an extended weekend–three days to contemplate all that is wrong in the markets these days. Superstar NVIDIA continued to struggle as traders mulled export restrictions while UNH tumbled under Federally mandated restrictions from the Biden era. The President’s bristling over neo-hawk Powell’s stance put the Dollar and Treasuries in the cross hairs of sellers. Growth-darling Netflix to market: “we chill–no worries.”
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