What US Slowdown?

Since July 2018, the US and China have been engaged in an escalating trade conflict. It has embroiled not only these two superpowers but every economic region around the globe too.

The fact Trump is sticking to his ‘tariff man’ rhetoric has been a growing concern because of its potential to undermine economic growth. Concerns have escalated and reached a point where financial markets are starting to price in interest rate cuts from the Federal Reserve (Fed), the US’ Central Bank. Recent forecasts suggest there is a 39% probability of the Fed reducing its rate from 2.50% to 1.75% by February 2020, as illustrated below. This would represent three 0.25% rate cuts.

Probability of US Interest Rate Reductions by February 2020

Source: Bloomberg, June 2019

If rates are cut, as now expected, it will mark a reversal from the Feds previous trajectory of interest rates rises that began in 2015, as illustrated below.

US Interest Rate

Source: Bloomberg, June 2019

The shifting focus to interest rates matters a great deal. They function as a key monetary tool helping central banks manage the economy. Putting them up can help cool an over-heated economy in the same way that reducing them can spur a stagnant one.

The impact of interest rate monetary policy changes are not immediate on the real economy but are transmitted very quickly into capital markets i.e. into equity and fixed income markets. Therefore, investors try hard to anticipate any changes, so they can benefit from resulting price movements.

Another aspect to be considered is that monetary policy judgements can be finely balanced. Getting the decision wrong is termed a ‘policy error’ and is only evident retrospectively. Policy errors can be costly because they undermine credibility in the people making the decisions.

Increases in interest rates over the past 4 years, and their impact on the economy, has been a hot topic generating keen debate. At times the decisions to keep increasing rates has caused disagreement between members making up the Federal Reserve board. They do have to reach a view and they coalesce around a desire to sustain growth over the long term i.e. not to maximise it in the short to medium term. They also act independently of the US administration regardless of who is in government.

Recently, President Trump has been increasingly vocal on the topic, venting his displeasure toward Jerome Powell the Fed’s Chairman. Trump has also admitted to the fact he believes US interest rates should have been cut already. This has angered some people who say he is acting against the spirit of the Fed’s mandate to act independently.

Source: Twitter, April 2019

Not content with tackling the US central bank Donald Trump has since fired off an angry tweet about the European Central Bank after they announced that they could lower interest rates.

Source: Twitter, June 2019

Trump’s desire for the Fed to cut rates is because he wants to turbo charge the US economy. However, this may not be happening as quickly as the President would hope. Data released earlier this week indicated that retail sales rose by 0.5% from the month prior, surpassing expectations of 0.3%. This shows consumption expanding despite the deepening trade war with China.

The strong data on consumer spending also caused some forecasters to upgrade their estimates for US economic growth for the current quarter. JPMorgan revised their estimate up from 1% to 1.75%. However, this still points to a modest slowdown in US growth. While a slight slowing of growth might be regarded as acceptable in the current climate, it is unlikely to satisfy President Trump who has ambitions for much higher growth.

Given this strong data, the Fed voted to keep rates on hold. However, it was noted that they dropped the use of the word ‘patient’, which has been used by them previously to describe their approach to rate setting. The inference of them dropping this one word is that it opens the door to rate cuts very soon.

Trump isn’t noted for his patience and if interest rates are not cut at the next Fed meeting in July we should expect to see a barrage of tweets on the need for more action. For now he seems happy to taunt Mario Draghi, Powell’s counterpart in Europe, that Europe is benefitting at the expense of the US.

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