Fed wrestles with trade uncertainty ahead of second rate cut

Fed wrestles with trade uncertainty ahead of second rate cut

Sales have been great this year for Winton Machine, a 35-person firm in Suwanee, Georgia, that makes machines that bend metal tubes. Lisa Winton, chief executive, attributes its success to landmark tax reforms signed into law by US President Donald Trump in 2017, which freed up cash for other manufacturers to put her gear on their plant floors.Demand has risen by so much that she now needs to move into a bigger plant. But she is putting off the decision. “I’m just holding tight,” she says, “because of that uncertainty”.The uncertainty she is referring to is swirling around trade, as Mr Trump has escalated, de-escalated and re-escalated his trade war with China, and threatened traditional allies with tariffs, too.The Federal Reserve, under its chairman Jay Powell, is expected this week to cut interest rates by a quarter point for the second consecutive policy meeting. The White House, however, is keeping up its drumbeat of demands for greater monetary easing, and both inside and outside the Fed there are concerns the central bank has been underestimating the economic consequences of trade uncertainty. If the Fed decides to recalibrate, it could end up cutting rates more aggressively.With the rules of the road for importing or exporting businesses changing from presidential tweet to tweet, fixed nonresidential investment, a measure of business spending on new equipment, has been slowing since the summer of 2018. Sales of industrial machinery — what Ms Winton makes — grew slightly in the second quarter, but overall investment turned negative, dragged down in part by a steep drop in new commercial buildings.

The Economy is great. The only thing adding to “uncertainty” is the Fake News!

© AP

Torsten Slok, chief economist at Deutsche Bank, pointed to other indicators that have also been dropping since the start of the trade war. Average weekly hours have declined in manufacturing, as have overtime hours. The reason, he suggested, is that uncertainty has begun to play a bigger role in real decisions.It could be that uncertainty “just simply is very, very critical exactly when you enter some abnormal or distressed period,” he said.Economists tend to be sceptical about whether the impact of uncertainty on economic sentiment translates into reduced spending – and for that reason they minimise its importance in their models. But that could be a significant mistake.Jim Bullard, president of the St Louis Fed, said there were two basic states of trade uncertainty. “It was low,” he told the Financial Times last month, “now it’s high.” He argued that under high uncertainty, firms behave differently, and are more cautious with investments.“Whether we’ve done as much as we need to here is a good question,” Mr Bullard said, referring to the Fed’s policy response to trade uncertainty. “But I think we have taken this on board, for sure.”The Fed’s board of governors released a paper this month that attempted to quantify uncertainty — and its consequences — with more precision. The authors tracked newspaper reports and company analyst calls for mentions of trade policy back to 1960. The escalation of the trade war in 2017 and 2018 could put a drag on business investment of between 1 and 2 percentage points, it concluded — in line with alarming surveys on business’s investment plans carried out by the Atlanta Fed. Crucially, the Fed’s paper distinguishes between actual tariffs and concern over potential tariffs. The drop in investment comes not from the tariffs, but from the concern.

Fed chair Jay Powell has come under pressure from President Donald Trump to bring interest rates down sharply © AP
“When you have trade negotiations, you can envision that we will be in agreement in the end,” said Michelle Meyer, chief US economist for Bank of America Merrill Lynch. “You may have to adjust, but there will be some sort of answer, there will be a resolution, and you can plan to that. But if there’s just persistent trade uncertainty, how do you plan in that environment?”Mr Trump has continued to harry the central bank on Twitter for more aggressive action. “The USA should always be paying the lowest rate. No Inflation! It is only the naïveté of Jay Powell and the Federal Reserve that doesn’t allow us to do what other countries are already doing. A once in a lifetime opportunity that we are missing because of ‘Boneheads’,” the president wrote last week.But in an earlier tweet, Mr Trump said: “The Economy is great. The only thing adding to “uncertainty” is the Fake News!”
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Lisa Winton, the chief executive in Georgia, is worried about the trade war with China — she relies on some parts that can only be sourced there — and even more about congressional approval for the new Nafta trade deal with Mexico and Canada, known as the USMCA, which she has travelled to Washington to advocate for.But even if uncertainty has played a small role in economists’ models until now, it has always affected her business. She had noticed, for example, that sales drop in every presidential election year — and does not know why.“When you get that answer, let me know,” she said. “I need less uncertainty.”


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