A Tale of Two Narratives
The capital markets can’t seem to decide if it’s the best of times or the worst of times.
All year, the markets have been driven by two dominant narratives. Those narratives involve Federal Reserve policy and what’s going on in China. In each case, the default has been to assume a positive stock market spin (the best of times), but those defaults can be undone by news, as it was last week, and feel like the worst of times in a hurry.
President Trump wants the markets to focus on the Fed narrative, but the markets are currently focused primarily on China.
On March 1, 2018, Mr. Trump announced a 25 percent tariff on steel and a 10 percent tariff on aluminum imports. The next day, he tweeted, “Trade wars are good, and easy to win.” One week later, the president signed an order to impose the tariffs effective after 15 days. Since then, U.S. Steel shares are down 73 percent and the U.S. economy has notably weakened.
Growth has slowed, probably to around 2 percent, manufacturing is down, and the trade deficit has gotten bigger, not smaller. Yet it’s by no means clear that we’re heading for an actual recession, despite many who are calling for it. That said, President Trump and his inner circle have been acting as if the sky were falling. Mr. Trump is lashing out at what he considers a conspiracy to get him. He’s accusing the Federal Reserve of sabotaging his boom, even though interest rates are actually a lot lower than his administration projected in its own rosy forecasts from last year. And the president is blaming Democrats who, he says, are “trying to ‘will’ the Economy to be bad.”
Not surprisingly, Mr. Trump and his advisors say there are no signs of recession. Still, while claiming that the “Economy is very strong,” the president also called for “at least 100 basis points” of easing, “with perhaps some quantitative easing as well.” That is the sort of drastic policy action from the Fed that is used to try to forestall truly dire economic outcomes that seem inevitable.
What is perhaps most striking about all this posturing is the panic displayed. The mixed message: Everything is great, but we need a huge stimulus immediately.
The greatest threat to any president’s reelection bid is a weak economy, and that is especially so for President Trump, who has bet his administration on his economic prowess. And the biggest threat to the economy is Mr. Trump’s trade war.
Conventional wisdom still says a trade deal gets done, at least eventually, but I’m not so sure. That’s because (a) China, as an authoritarian government, can force its people to hold out indefinitely, potentially driving Mr. Trump out of office; or (b) China can give the president something to allow him to claim victory while driving a very hard bargain otherwise. Both of those scenarios are bad for the U.S.
These narratives reached a climax on Friday. Fed Chairman Jerome Powell conceded in a speech that the Fed has no playbook for the president’s trade war and the damage it is doing to the American economy. He warned that “trade policy uncertainty” is a driving factor for the market’s fears. President Trump, after dumping on the Fed all week, proved the point just minutes thereafter.
U.S. stocks slumped early Friday after China said it would impose retaliatory tariffs on $75 billion in additional U.S. products. Mr. Powell’s speech followed, after which President Trump vowed to respond to China. On Friday alone, the Dow lost 621 points, or 2.37 percent. The Nasdaq lost 3 percent, and the S&P 500 was off 2.59 percent, closing out a fourth straight down week. Yields on U.S. government bonds tumbled, as did commodities markets that are sensitive to the two countries’ trade battle.
After market close, President Trump responded, saying he’s raising tariffs further, deepening the impasse over the two nations’ trade policies. Duties on $250 billion of imports already in effect will rise to 30 percent from 25 percent on October 1, Mr. Trump announced in a series of tweets. He also said that the remaining $300 billion in Chinese imports will be taxed at 15 percent instead of 10 percent starting September 1. Those moves are likely to weaken stocks and economic conditions even more.
It just might be harder to win this trade war than we were led to believe.
From the headlines…
Federal Reserve Chairman Jerome Powell faces scrutiny from markets and the White House over his stewardship of interest rates in an economy unsettled by a trade war with China and fears of recession. Despite traders hoping for aggressive easing, Fed minutes released last week show that Fed officials saw their move to cut interest rates last month as a recalibration rather than the start of a more aggressive easing cycle and were reluctant at their latest policy meeting to say how future moves would unfold. Mr. Powell’s challenge in the weeks ahead is to articulate clearly why the central bank is likely to continue reducing rates absent obvious signs of economic deterioration.
Multiple studies, from researchers at Harvard, Columbia, the IMF, and two different branches of the Federal Reserve, have all concluded that the tariffs imposed by President Trump on China and others have hurt American consumers and threatened economic growth. For instance, scholars at Columbia, Princeton, and the New York Fed found that Mr. Trump’s tariffs had reduced U.S. real income by $1.4 billion per month by the end of 2018.
The U.S. Treasury is considering the issuance of 50 and 100-year bonds. In related news, the U.S. budget deficit is now expected to breach $1 trillion by 2020, two years earlier than previously projected. Surprisingly few countries have taken advantage of crazy-low rates to issue ultra-long bonds.
According to The Wall Street Journal, “more than 50 percent of America’s $22 trillion in outstanding debt matures in the next three years. The weighted average cost of that debt rests at less than 2 percent. A rise to 3 percent would increase the deficit by an astounding $220 billion a year.”
Worldwide, there is now $17 trillion of negative yielding sovereign debt and over $40 trillion of negative real yielding debt in total. For example, Germany auctioned a 30-year bond last week with a 0 percent coupon for the first time. The instrument sold with a record low yield of -0.11 percent.
Existing-home sales in July rose 0.6 percent from a year earlier, the first year-over-year uptick in 17 months and possibly a sign that lower mortgage rates are finally starting to drive sales after a weak spring selling season. However, the Labor Department reported that employers added a half-million fewer jobs in 2018 and early 2019 than previously reported, the latest evidence that the economy got less of a jolt from President Trump’s tax cuts than it initially appeared.