Trump's Fed Smackdown Could Backfire

The denunciation of the Fed by Trump goes against the policy of the last administrations to maintain respect for the independence of the central bank. But he was consistent with his penchant for criticizing the Fed when he thought it did not work in his favor.

During the 2016 election campaign, Trump described himself as a "low interest rate person", which is not surprising. He is also described as the "king of debt" for his propensity to borrow heavily to finance his real estate operations. "Nobody knows debt like me," he said at the time. "I made a fortune using debt, and if things do not work out, I renegotiate the debt." (Or default? It's another story.)

Lest someone thinks that the low-interest person has lambasted the Fed's President of the United States. Janet Yellen, in 2016, declaring that she should be ashamed to keep interest rates at a low level, which created a fake stock market. their money "got practically zero interest on their money."

Two years later, Trump's air has changed. CNBC said it feared the Fed would further increase its interest rate manager twice this year, although advisers have informed the president that the central bank is doing the right thing. The Fed has raised a quarter of a point its key federal fund rate target twice in 2018, from 1.75% to 2% currently. While there is a 90% probability of another similar rate hike in September, according to Bloomberg, an additional quarter-point move in December has a probability of about 62% .

Respect and even respect for the Fed's independence a relatively new state of affairs. Robert Rubin, Treasury Secretary of the Clinton Administration, put in place a policy of protection against the Fed while declaring a "strong dollar" policy, which was followed to varying degrees by the following two administrations.

exception, however. The standoff between sound money and cheap money has gone through the entire history of the United States, going back even further than William Jennings Bryan's famous speech, "Cross of Gold" , in 1896. There would be other clashes later. Notably, Lyndon Johnson and Richard Nixon both tried to influence the Fed, as I discussed on Barrons.com ("Trump Breaks Previous in Fed Criticism," July 19).

Greg Valliere, chief strategist at Horizon Investments, thinks the Fed's criticism could backfire. The current president, Jerome Powell, "is a savvy pro, resistant to political pressure – but he surely thinks of market perceptions," writes Valliere in a guest note.

If the Fed raises twice as much this year and three times 2019, Powell could be criticized not only by Trump but also by liberal Democrats like Elizabeth Warren and Bernie Sanders, Senators of Massachusetts and Vermont, respectively. But if the Fed raises rates more slowly, the suspicion on the market could be that Powell flames under political pressure. "No matter what he does, his motives will now be questioned," says Valliere

The biggest battleground may be with China, on which Trump has threatened to impose tariffs on 500 billion dollars of imports. The Chinese currency, the yuan, has fallen sharply in reaction, raising fears that the exchange rate will be used as a weapon in the growing trade conflict. Marc Chandler, Brown Brothers Harriman's currency strategist, in doubt. The recent fall of the yuan comes after its outperformance in the first quarter and against a strong dollar. The Chinese authorities also seem to have used a verbal intervention Friday to stabilize their currency, he notes.

Here is the biggest question: if Trump pushes against higher interest rates and a strong dollar while the US economy is doing well and the stock market "

The yield curve is flickering in yellow

Even before President Trump presented his point of view on interest rates last week, the yield curve was the subject of intense debate, notably

. Interest only topic for bond nerds, the yield curve is a chart of short and long term bond yields, ranging from one day to 30 years. But the typical shortcut is to describe the curve in terms of the difference or difference between two points of the curve.

The most common focus is the gap between the two-year Treasury note, which reflects market expectations for future short-term rate changes by the Federal Reserve, and the US dollar bill. 10 years, which is the benchmark for longer maturities.

The 2 to 10 s spread was contracted steadily, reaching last week 25 basis points (a quarter of a percentage point). It was the flatter since July 2007. The Great Recession began in December of this year, although it is only apparent later.

A flatter yield curve looks like a falling barometer and indicates an economic storm. This is because the flatter slope almost always comes from the elevator of the short portion of central bank rate increases. And the flattening of the current curve follows seven Fed hikes of 25 basis points from December 2015, the latest being last month and bringing rates between 1.75% and 2%. Another increase of this kind and, all else being equal, the gap of 2 to 10 would probably be zero, suggesting a future recession.

But there are other gaps to consider, and they do not present a forecast as well. Barron's contributor Mark Hulbert, remarked on MarketWatch that the gap between three-month treasury bills and the ten-year note implies a much lower probability of a recession imminent. Citing a widely used model based on Arturo Estrella, currently a professor at the Rensselaer Polytechnic Institute, and Frederic Mishkin, former Fed governor and professor at Columbia University, there is only a 10% chance of recession in the 12 next few months.

The yield curve is far from being an infallible indicator. Indeed, it has been distorted by extraordinary actions of central bankers around the world as a result of the financial crisis. Capital Economics, an economic consulting firm, points out that the world's lowest interest rates have led to yield curves everywhere. Bank of America Merrill Lynch economists add that weak European yields, reflecting economic and political factors (the anti-establishment Italian government, the political problems of Angela Merkel in Germany), have been a major factor weighing on longer-term US yields.

But combining performance with other leading indicators can provide more robust forecasts. Michael Darda, chief economist and market strategist for MKM Partners, writes that the combination of a negative spread between one- and ten-year treasury bill yields and negative real growth (after deducting the effect of the first quarter of the year) is expected to have a negative impact. tightly defined monetary supply inflation M1) predicted a recession of three to eight quarters. However, the Darda data show that the yield spread and the growth of real money are not negative.

Another model using the same spread and credit measures could start to flash. This comes from Paul L. Kasriel, author of the blog Econtrarian. A former Chief Economist with Northern Trust, he is now Senior Investment and Economics Advisor at Legacy Private Trust in Neenah, Wisconsin.

Kasriel's model combines the gap between one- and ten-year bonds with what he calls the "air credit" – the monetary base, which the Fed creates by buying securities with money created by a few strikes, and commercial bank credit, which banks create by issuing loans.As the Fed slows the growth of the monetary base, the rate of federal funds increases, resulting in a slowdown This, in turn, implies slower growth in overall spending.The yield gap has narrowed since 2014, to 43 basis points at the end of the year. last week, while growth in its definition of thin air credit has slowed in tandem.

The Fed is expected to raise the fed funds rate by 25 basis points in September, but another rise in December is expected allow you to "reduce recession traps in 201 9 ", says Kasriel, how could this be done, given that gross domestic product growth in the second quarter should be a 4.5% blockbuster? "Just like pride before the fall, coincide the indicators go up before a recession," he says.

Up to now, the warning lights start to flash yellow. In parallel with the yield curve, the stronger dollar and the decline in gold and industrial products such as copper all suggest slower liquidity growth. Although the economy is strong now and equities hold at or close to their peak, a tighter, at best, wind is the opposite, if not a sudden blow. wind.

Write to Randall W. Forsyth at [email protected]