19 Sep

Will the Rate Cut Force Trump to Abandon the Trade War?

WRITTEN BY Mike Sonnenberg

In a second consecutive instance of monetary easing, the Fed cut the federal funds rate by 25 basis points to 1.75%–2% yesterday. Out of ten Fed members, seven approved of the 25-basis-point rate cut, while three dissented. Interestingly, two of the three dissidents, Boston Fed’s Eric Rosengren and Kansas City Fed’s Esther George, wanted no rate cut at all, while St. Louis Fed’s James Bullard wanted a 50-basis-point cut. Rosenberg and George also disagreed with a rate cut when the Fed cut rates for the first time since 2008 in July.

The committee was also divided about the path of rate cuts this year. Five Fed officials want no change for the remainder of 2019, five see rates going back to the previous range of 2%–2.25%, and seven expect another rate cut in 2019.

Powell doesn’t see an aggressive rate cut for now

While speaking to media after the decision, Fed Chair Jerome Powell highlighted that the Fed was “not on a preset course.” He noted that more aggressive rate cuts may be the need of the hour if economic indicators point to weakness. However, the Fed doesn’t expect that to happen. Thus, communication regarding further easing remains unclear.

The broader S&P 500 Index (SPY), which was trading in the red before the Fed’s decision, ended flat yesterday. However, S&P 500 futures were trading 0.2% down at 4:48 AM ET today. Major bank stocks ended in the positive, with JPMorgan Chase (JPM) closing 1% up yesterday. Bank of America (BAC), which was in the red before the decision, ended the day with a 0.2% gain. It saw this gain despite reports of investigations into unauthorized accounts.

Trump slams the Fed

President Donald Trump, who has been at odds with the Fed, was quick to slam its decision in a tweet. He said that Powell and his Fed colleagues had “no ‘guts,’ no sense, no vision!” President Trump has been demanding more aggressive rate cuts, even asking for negative interest rates. The Fed’s measured rate cut decision has surely disappointed the president, who is fighting a two-pronged quasi-war with the Fed and China. In a way, Trump may be hoping to hedge his trade war belligerence with a super-dovish monetary policy from the Fed.

The trade war is hurting the president

President Trump has been asking the Fed to cut rates more rapidly for months now. His pitch has become more aggressive, as the US economy is seen to be hurting from his own trade war with China.

The US manufacturing purchasing managers’ index, a leading economic indicator, points to a stagnating or even contracting US manufacturing sector. Job creation has slowed down too.

Instead of coming back to the US, companies leaving China are choosing other destinations. Google is moving the production of its Pixel smartphones to Vietnam, while Amazon is choosing the same country to produce its Echo devices. With tariffs on cell phones and other tech products coming into effect on December 15, the situation could get worse. Apple (AAPL) is also hurting from the trade war. It tried shifting production back to the US but failed in its attempt. Apple has been a vocal critic of Trump’s trade war.

Worse, companies such as Tesla (TSLA) are also looking to shift production to China to cater to the local market. Tesla is building a Gigafactory to produce its Model 3 in China. This way, it can escape the 25% tariffs China is scheduled to levy on US automobiles starting on December 15. The absence of tariffs coupled with lower production costs in China could help Tesla gain a competitive advantage over local players such as NIO.

Yesterday, FedEx (FDX) reported its fiscal 2020 first-quarter results. Its EPS fell sharply, and it provided a dismal outlook for the year. FedEx blamed the trade war for its gloomy performance and outlook.

The Fed won’t budge

Despite Trump’s threats and aggression related to the rate cut, the Fed has opted for a measured approach to monetary policy. Powell said that the future path of interest rates will be data-driven. He noted that the economy is expanding moderately, with household spending rising impressively. Weakness in business fixed investments and exports is acting as a headwind.

While the Fed expects the rate cut to help boost inflation, its release also acknowledged uncertainties.

Rate cut and Trump 2020

A rapid rate cut is important for Trump’s 2020 reelection bid. Other central banks around the world are also loosening their purse strings. The European Central Bank cut its already negative rates further and started a quantitative easing program at its last meeting. The Bank of Japan, although it’s maintained its rate at -0.1%, is expected to go for a rate cut in its October meeting. Although it strengthened in recent sessions, the Chinese yuan is also trading lower against the US dollar compared to the beginning of the quarter. Rate cuts make capital cheaper, boosting fixed investments. Rapid easing could have helped Trump boast a possible economic boost for voters.

Rate cut and the greenback

Apart from boosting fixed investments, a huge rate cut would also weaken the US dollar, helping US exporters. A weak dollar makes US goods relatively cheap for foreign importers in their own currencies. In the past, Trump has accused the Fed of letting the US dollar stay strong. He feels that US manufacturers such as Boeing (BA) are hurting due to a weak dollar. While the weaker dollar will help Boeing become more competitive regarding exports, we believe that the argument ignores Boeing’s current problems regarding its 737 Max 8 planes.

Time to end the trade war?

With the Fed not supporting his plans, Trump may have to abandon the trade war against China to improve business confidence and investments. However, he’s given conflicting signals in the past. He may even be thinking of doubling down on his rhetoric.

Trump recently warned China again not to wait until 2020 to make a deal—but perhaps it’s he who’s running out of time.

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