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Last month, as the trade war was stealing the headlines, annual summer camp was in session for international central bankers at Jackson Hole, Wyoming. There, Federal Reserve Chairman Jerome Powell remarked that the Fed is committed to continue to do what’s needed to “sustain the expansion.”
He noted that the U.S. economy is in a “favorable place,” although it faces “significant risks.”
He said that economic slowdown in Germany and China, the possibility of a hard Brexit and tension with Hong Kong contributed to a “complex, turbulent” picture. And he agreed that markets were volatile.
As you recall, the Fed decided to cut rates by 25 basis points on July 31. And many were listening to Powell’s speech trying to decipher whether he truly meant the rate cut was just a “midcycle adjustment” or if he was going to strike a more dovish tone.
Powell’s speech confirmed the notion that the rate cut did not necessarily signal strong dovish monetary policy to come. He didn’t give those wanting to hear strong dovish talk much to go on.
And no one wanted to hear strong dovish talk more than President Trump. This is what Trump tweeted after Powell’s comments from Jackson Hole:
As usual, the Fed did NOTHING! It is incredible that they can “speak” without knowing or asking what I am doing, which will be announced shortly. We have a very strong dollar and a very weak Fed. I will work “brilliantly” with both, and the U.S. will do great…
Here’s how he capped it off: “My only question is, who is our bigger enemy, Jay Powell or Chairman Xi?”
Recently, Trump had more to say:
The Federal Reserve loves watching our manufacturers struggle with their exports to the benefit of other parts of the world. Has anyone looked at what almost all other countries are doing to take advantage of the good old USA? Our Fed has been calling it wrong for too long!
Those are fighting words, calling the chairman of the Fed a downright enemy of the country, maybe worse than the Chinese leader who had just announced anti-U.S. tariffs.
Powell’s borne the brunt of President Trump’s repeated accusations that the Fed is what’s holding back the stock market and threatening the economy. Trump has publicly expressed frustration with Powell, believing he has negated the impact of the Trump tax cuts.
Presidents have normally refrained from publicly commenting on the Federal Reserve’s policies, allowing it to maintain at least a veneer of independence, as mandated by the Federal Reserve Act of 1913.
But whatever you think of him, you have to admit that Trump is no ordinary president. He’s certainly not one to keep his opinions quiet.
And that doesn’t mean presidents haven’t privately leaned on the Fed to help their reelection prospects.
Just look at another Republican president – Richard Nixon. When the Fed began raising interest rates during Nixon’s term, he also raised objections, although not in public like the current president.
Back then, the U.S. had been in the throes of a recession in the beginning of the 1970s. The Fed had cut rates by half to stimulate the economy. There was no quantitative easing (QE) program during that period.That’s because it wasn’t a banking crisis preceding that recession, so the level of Fed support wasn’t anywhere near as expansive as it has been this past decade.
Fed Chairman Arthur Burns believed that “awful problems” could occur if the Fed didn’t raise rates in tandem with the growing economy. On a somewhat lesser scale, that was the position of Jerome Powell before he backed off the rate hikes at the beginning of the year.
But here’s how Trump’s comments can affect Fed policy…
Trump is almost forcing Powell to cut rates by carrying on the trade war, which is taking a toll on the stock market and the overall economy. But Powell does not want it to appear like he’s caving into Trump’s demands.
The Fed is supposed to be independent of politics, even though it really isn’t. But it at least has to give the appearance that it’s independent of politics. If Powell starts cutting rates aggressively, it would make him look like a puppet.
But if he doesn’t cut rates, the economy and the stock market could suffer at a time when they’re most needed. As geopolitical tensions rise, trade wars mount, currency wars spawn and volatility continues to build, it’s clear the economy faces increasing pressure that could spiral into recession or worse.
The Fed can tolerate weakness in the stock market, but it fears a complete collapse, which is a very real possibility. So Powell’s in a catch-22, damned if he does and damned if he doesn’t.
Powell can look like he’s giving into Trump and keep the bubble going, which will only prolong the ultimate day of reckoning and make it worse, or he can withdraw support and risk a crash.
Ironically for President Trump, such friction could incite greater economic uncertainty, which could prove detrimental to the economic strength he desperately wants to maintain heading into the 2020 election.
Interestingly, former New York Fed President Bill Dudley is actually calling on Powell not to lower rates. Why not? Because it would help Trump win the election next year. To prove that the Fed isn’t independent of politics at all, Dudley said:
Central bank officials face a choice: enable the Trump administration to continue down a disastrous path of trade war escalation, or send a clear signal that if the administration does so, the president, not the Fed, will bear the risks — including the risk of losing the next election.
After all, Trump’s reelection arguably presents a threat to the U.S. and global economy, to the Fed’s independence and its ability to achieve its employment and inflation objectives. 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.
It doesn’t get much more direct than that for a former Federal Reserve official. So the next time someone tries to say the Fed is independent of politics, don’t listen to a word of it.
Ultimately, I believe Jerome Powell will be forced to cut rates because of slowing economic conditions.
It might look like he’s caving to Trump, but that’s just something he’ll have to live with. That also means more dark money will be coming to support markets.