Yesterday, in a series of late-night tweets, President Donald Trump attacked the Federal Reserve and Jerome Powell again, calling them “boneheads.” He even demanded the Fed cut interest rates to zero or below. The timing of the tweet is significant, as the Fed is meeting next week to discuss the state of the economy and to ponder the path of a rate cut.
The market expects a 25-basis-point interest rate cut to a range of 1.75%–2%. In its previous meeting, the Fed cut interest rates by 25 basis points—its first rate cut since 2008. Trump’s demand for subzero interest rates effectively means he wants a 2% rate cut. The S&P 500 Index (SPY) closed with a rise of 0.72%, while the Nasdaq (QQQ) gained over 1% due to easing trade worries.
Trump: Not making America great again?
President Trump has been demanding the Fed cut interest rates more quickly for months now. The pitch has become more aggressive, as the US economy is seen to be hurting from Trump’s own trade war with China. The US manufacturing PMI compiled by the Institute of Supply Management, a leading economic indicator, ended up in a contraction zone in August for the first time in three years.
Instead of leaving China and coming back to the US, American companies seem to be looking elsewhere. Google (GOOG) (GOOGL) is moving the production of its Pixel smartphones to Vietnam. Trump’s 15% tariffs on cellphones will come into effect on December 15 and will hurt Google’s Pixel and Apple’s iPhone. Google was in the trade war spotlight in May when it suspended business with China’s Huawei. Apple (AAPL), which unveiled its latest iPhone this week, is mulling over moving 30% of its production out of China. Apple has tried shifting production back to the US but failed in its attempt. Apple has been a vocal critic of Trump’s trade war.
While some US companies are planning to leave China, Tesla (TSLA) is building a factory there to produce its Model 3 electric cars. By moving production to China, Tesla will escape the 25% Chinese tariffs on American cars that are set to come into effect on December 15.
A slowdown in job creation
In August, the US economy added 130,000 jobs, undershooting expectations. In 2019 so far, the pace of job creation has been about 158,000 per month compared to 223,000 per month in 2018. A Bloomberg report on September 5 said that over 10,000 Americans have lost their jobs due to the trade war. Companies such as Uber (UBER) are also laying people off to cut their losses. On Tuesday, TechCrunch reported that Uber had laid off over 400 people on its engineering and product teams. In the current quarter, Uber has also laid off 1,200 marketing personnel.
Apart from economic indicators, bond yields are also flashing warning signs for the economy. While yields across maturities have moved up and the yield curve has shown an upward-sloping bias lately, shorter-term bond yields (SHV) remain higher than medium-term Treasury bond yields (IEF). Even long-term yields (TLT) remain subdued.
While there are different opinions regarding the Treasury yield curve as a predictor of a recession, the current yield curve definitely doesn’t point to a healthy economy.
Why President Trump wants a huge rate cut
With slowing manufacturing, subdued job creation, and other recessionary signals flashing, President Trump needs fiscal or monetary policy initiatives to boost the economy ahead of his reelection bid.
Fiscal measures are hard to get approved in a divided Congress. Moreover, the US is already leveraged. Fiscal measures also take time to show up in economic indicators, and Trump may not have enough time at hand for that with the Iowa caucuses happening in February.
Thus, the Fed’s loosening its purse strings is the best scenario for Trump’s reelection bid. Attacking the Fed constantly could be Trump and his team’s poll strategy.
A huge rate cut would also result in weakening of the US dollar. A weak dollar means US exporters will be more competitive. Last month, Trump targeted the Fed for letting the US dollar stay strong by keeping interest rates high. He added that the strong dollar is making it difficult for US manufacturers such as Boeing (BA), Caterpillar, and John Deere to compete. A weaker dollar may not help Boeing be more export competitive. Right now, the company is battling regulatory issues around the world.
What negative interest rates could do to the stock market
Trump may be trying to time next year’s election in intensifying his call for a huge rate cut. A zero or negative interest rate could provide a short-term breather to the US economy, which looks overheated. The evidence that negative interest rates can help boost the economy is rather weak. Japan and Europe have maintained negative interest rates for years, but the strategy hasn’t exactly supercharged their economies.
Low interest rates could give rise to risk-taking in two ways. First, low interest rates mean cheap capital. Access to cheap capital may make investors take risky bets. Second, low or negative interest rates can push investors toward riskier assets in search of higher yields. Thus, zero or negative interest rates have the potential to fuel the next stock market bubble (and burst).
Since the next term will be his last if he’s reelected, Trump may not have to answer to the public in the same way about the stock market crash (if it happens after reelection). That price could be for other Republicans to pay.
JPMorgan Chase is preparing for a rate cut to zero
Yesterday, JPMorgan’s (JPM) CEO, Jamie Dimon, said that the bank is preparing for zero interest rates. If rates fall to zero, JPM’s margins could take a hit. As a result, the bank will have to cut costs and increase client fees to make up for it. Back in July, JPMorgan predicted a market crash in the current quarter.