Trump tariffs increase pressure on Fed to cut rates
After the Federal Reserve trimmed interest rates by a quarter point on Wednesday, Donald Trump lashed out at its chairman, saying Jay Powell had “let us down” by failing to cut even more.
A day later, Mr Trump issued a new tariff threat against China that could force Mr Powell and other central bank officials to do precisely what the US president wants: much more aggressive monetary easing.
Mr Trump said the US would move ahead with new levies of 10 per cent on all remaining Chinese imports — worth $300bn — after high-level talks in Shanghai to resolve the commercial conflict between the world’s two largest economies ended with another impasse this week. The levies would come on top of the 25 per cent tariffs that already apply to $250bn of Chinese goods.
If implemented as threatened on September 1, the new tariffs could deal an additional blow to the global economy at a time when growth is already slowing, doing particular damage to manufacturing businesses around the world that are heavily dependent on trade.
For Mr Powell, the tariff threat by the White House could serve as validation of the Fed’s rationale for pursuing interest rate cuts in the first place, which is primarily based on neutralising the risks from trade unrest and global economic weakness.
It will also raise the possibility of the US central bank getting dragged into a much deeper monetary easing cycle because of the economic damage looming from Mr Trump’s trade policies, rather than the milder, preventive “mid-cycle adjustment” to interest rates it is intending.
“Not only does this bring lower rates, but it puts more immense pressure on the Fed to do something more sooner rather than later,” said Jim Paulsen, chief investment strategist at Leuthold Group.
Some strategists said they worry that a dangerous spiral might develop, in which the Trump administration keeps escalating the trade war in the belief that the Fed will be there to cushion the blow.
“This is the thing that I was most worried about: that the administration would believe that an easier Fed gives them license to get tougher on the trade war,” said David Kelly, chief global strategist at JPMorgan Asset Management.
“Tariffs are not a stairway to heaven. They are a ladder to hell, and now we are one rung further down that ladder.”
During his news conference this week, Mr Powell acknowledged that the Fed faced a quandary in making monetary policy decisions based on fraught and unpredictable trade relations — a collision of two worlds that normally operate independently.
“Trade is unusual,” Mr Powell said. “The thing is, there isn’t a lot of experience in responding to global trade tensions. So it is something that we haven’t faced before and that we are learning by doing.”
The Fed chairman warned that there had already been some impact on the US economy, which has posted weaker manufacturing and investment data. But he also noted that concerns about trade had eased in the run-up to the Fed’s decision.
“After simmering early in the year, trade policy tensions nearly boiled over in May and June, but now appear to have returned to a simmer,” the Fed chairman said.
That was Wednesday. Less than 24 hours later, trade angst between the world’s largest economies was back on the rise. Not only did Mr Trump say that the US was poised to slap 10 per cent tariffs on a vast new range of Chinese goods, but he also signalled that he could raise those levies to 25 per cent. Meanwhile, EU trade relations have deteriorated in recent months, with the prospect of tariffs on auto imports looming in the autumn.
The flare-up on trade also increases the risk of a currency war, particularly since Mr Trump — and many lawmakers on Capitol Hill — are displeased with the strong value of the dollar. Last week, Mr Trump denied that he had ruled out currency intervention to weaken the greenback — a move that would also put the Fed in an awkward position because it would have to decide whether to participate in the action.
Much will depend on the Chinese reaction to Mr Trump’s new threat, including whether and how they might retaliate, and whether they are willing to return to the negotiating table next month as planned given the shadow of a new batch of tariffs. The concern will be that Mr Trump’s move, far from putting pressure on Beijing and forcing concessions, will backfire and encourage China to dig in further, complicating the task for both the Fed and investors trying to assess the situation.
“Markets are dealing with two countervailing forces, with the Fed supporting risk assets and calming markets and then we have the trade war inflaming market volatility and sending investors towards safe haven asset classes,” said Kristina Hooper, chief global market strategist for Invesco. “We’ll continue to see that same tug of war.”