A week when politics continued to trespass into monetary policy

Friday, 2nd August 2019 11:03 - by Shant

It has been quite a week in the US, with the highly anticipated FOMC announcement delivering what many had expected from policymakers, in terms of action.  After a number of week's debating whether the Federal Reserve would cut by 25 or 50ps, the markets had to settle for the lesser amount as the economy continues to show healthy dynamics, which at present focus on the labour market and consumption.   On that basis, adjusting policy for the real economy was a matter of delivering an 'insurance cut', given the external risks which are expected to impact on the US economy at some point in the future.  As has been attested to, business investment has been lagging and contracted in Q2 for the first time since 2016.  As such, there was some justification for Wednesday's move despite dissenting votes from Fed members Esther George and Eric Rosengren.  Given this obstruction, pushing for a 50bp move was a tough ask, and even the dovish leaning James Bullard calling for just 25bps at this stage. 

However, this was clearly not enough for the White House, where the president looks overseas and measures Fed policy relative to their counterparts in the major trading partners.  Europe and Japan are embarking on monetary stimulus - the latter it seems perennially - and (in his words) President Trump has 'let the side down' this week.  To add to the disappointment, the press conference did not cover Jerome Powell in glory, with criticism coming from all sides.  This was a communication which was low on conviction and clarity, contradicting himself to a degree when mentioning that this was not the start of an aggressive easing cycle, yet saying that he did not say that there would be no more cuts.  Which was it?  The communique was further soured by questions from Steve Liesman from CNBC who encapsulated the mood by asking just how the market could judge how and why they were conducting policy.  Very apt I thought.  This was not Jerome Powell's finest hour. 

However, the killer blow came the day after as the president suddenly decided to up the ante on China, and announced that he would be adding a 10% tariff on $300bln of Chinese goods.  While he admitted that this could be a short term move - to be applied at the start of September - he did also suggest that the levy could be raised to 25%, so the rhetoric was clearly designed to bring China quickly back to the table to thrash out a deal that the US deems acceptable.  For now, China seems ready to play the long game, as they sense these combative measures will ultimately hurt the US economy.  And that is where the Fed comes in.  Part of the validation of the 'insurance cut' is due to global factors, which is assumed to mean trade policy and in turn the actions of the White House.  So on that basis, the move by the president could be seen as a no-lose situation, as the consequences are effectively that of coercing China to submit ground in the negotiations, or for the Fed to deal with the consequences if they do not.  

As cynical as this may be, it is a plausible one, given the surprise element of the decision as well as the timing.   Needless to say, the futures market are now pricing in a 25bp cut at the September meeting, with the odds currently at 90% - which is not far off those for the Wednesday's move.  Whether this will be enough to stave off the current mood in equities remains to be seen, but the damage may have been done from the erratic nature of the White House move.  In light of this, it is also worth pointing to the pricing of the December FOMC meeting where the odds for rates to be trimmed by 1% (at that point) have now risen to 25%! 

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.