Ex-NY Fed president urges central bank to buck Trump

Why US bond yields could be going the way of Germany and Japan

A key former Federal Reserve policymaker has stirred debate with a controversial essay about how the US central bank should respond to a worsening economic outlook brought about by the Trump administration’s trade war with China.

Bill Dudley, the former president of the Federal Reserve Bank of New York, said the central bank, in order to achieve the goal of a healthy economy, should “refuse” to dole out stimulus to cushion the damaging effects of the trade war and urged officials to consider how their decisions could even affect the outcome of next year’s presidential election.

The comments from Mr Dudley, who was also the previous vice-chairman of the interest rate setting Federal Open Market Committee, come in the wake of last week’s annual central banker powwow at Jackson Hole, Wyoming, where Fed chairman Jay Powell similarly raised concerns about how the Fed responds to uncertainty around the trade war.

“Trump’s re-election arguably presents a threat to the US and global economy, to the Fed’s independence and its ability to achieve its employment and inflation objectives,” Mr Dudley wrote in an op-ed for Bloomberg.

“If the goal of monetary policy is to achieve the best long-term economic outcome, then Fed officials should consider how their decisions will affect the political outcome in 2020,” he concluded.

Mr Dudley said conventional wisdom suggests that if the trade war with China harms the US economic outlook, the Fed should respond by easing monetary policy. Such a response may prove ineffectual, or may make matters worse, “if the Fed’s accommodation encourages the president to escalate the trade war further, increasing the risk of a recession”.

Mr Powell said at Jackson Hole that positioning trade uncertainty into the central bank’s policy framework was a “new challenge”, acknowledging the Fed’s hands are tied in its ability to influence international trade negotiations.

Mr Dudley suggested that officials could take this line further and “state explicitly that the central bank won’t bail out an administration that keeps making bad choices on trade policy, making it abundantly clear that Trump will own the consequences of his actions”.

This, he said, would benefit the Fed and the economy by discouraging further escalation of the trade war, reassert the central bank’s independence by putting distance between itself and White House policies, and allow the Fed to save its policy bullets when interest rates are already at low levels by historical standards.

Ebrahim Rahbari, chief G10 currency strategist at Citigroup, said the resilience of the US economy and the Fed’s ability to react is something that allows Mr Trump greater freedom in making policy decisions that, in principle, pose risks to the US economy.

“Monetary policy is not the answer to trade policy issues. It is a very crude way of dealing with the uncertainty,” he said.

Traders are currently pricing in a 94 per cent chance the Fed will cut its benchmark interest rate by 25 basis points at its upcoming meeting in September, with the odds of a more aggressive 50 basis point cut diminutive at 6 per cent. Following Mr Powell’s speech at the Fed’s annual meeting in Jackson Hole on Friday and Mr Trump’s threat of fresh tariffs on China, the probability was as high as 17 per cent.

Should Mr Powell proceed with a quarter-point cut in less than a month’s time, markets are pricing at least another three cuts by the end of next year.

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