By David Nelson, CFA
After 18 months, in office no one should be surprised when President Trump takes to social media to weigh in on any number of taboo topics. He speaks in stream of consciousness weighing in on whatever is in his mind at the moment. The lack of editorial control has forced our nation to focus on important topics like the lack of NATO spending by our allies or China’s continued theft of our intellectual property. The other side of that dynamic is an unfortunate speech in Helsinki and now last week’s interview with CNBC anchor Joe Kernen.
With just a few off the cuff remarks, President Trump ended long standing policy to avoid politicizing the Federal Reserve saying “I don’t like all of this work we are putting into the economy and I see rates going up…”
My readers know where I stand on the Fed pointing out often that they are failing to read the hand writing on the wall. We seem to march closer to a flat or inverted curve with each passing week. The Fed’s own research reminds us that every recession since 1955 has been preceded by an inverted yield curve. However, when it comes to the independence of the FED, the President and I part company.
Throughout his interview with Mr. Kernen, President Trump referred to his pick of Jerome Powell the new Fed Chairman as a good one but continued to point to the unintended consequences of tightening too quickly putting us at a disadvantage with our trading partners in Europe and of course China.
Again, the President is correct, but the bigger danger is a politicized Federal Reserve incapable of making the tough call when warranted or needed quick decisions like those during the financial crisis.
The only thing worse than an Independent Fed is one that is not!
If the September meeting was at all in doubt, I think that’s gone now. Fed Chair Powell has no choice but to push a hike through to re-enforce Fed independence.
Few economists were looking to the August 1st meeting, but September probability was close to 90% for another rate hike. Anxious to normalize the Fed has raised rates 7 times since 2015 putting us at 2.0% with mean estimates of 2.9% by the end of the year. That would imply two more hikes before year’s end. The good news is that the out-year estimates suggest a terminal rate that stops at just 3%.
Its true inflation has picked up, especially on the heels of a 49% rise in crude. In addition, most of the economic indicators here in the states including employment show a robust economy and a vibrant consumer. Never the less, the United States doesn’t live in a vacuum and for now central banks of many of our trade allies are still running ultra-low rates.
Japan is still running a negative funds rate and the German 10 year is at just 37 basis points. This is the end of the experiment and the other side of normalization after a decade of ZIRP (Zero Interest Rate Policy) is unknown. It’s true the long end of our curve is being held back by other central banks but while the Fed implies they aren’t concerned about the flattening curve you can bet every economist will put pen to paper when it takes place.
As analyst Dick Bove pointed out in a recent article, Trump could change the makeup of the Fed with two governors waiting for confirmation adding more latter to fill current vacancies. For the most part, I give Mr. Powell high marks with his plain-spoken approach in explaining Fed policy. Gone are the days of Fed double speak that took an army of interpreters to decipher.
Fed History
The modern day Federal Reserve System was born in 1913. After a long history of financial panics and even a bailout by financial mogul J.P. Morgan, the stage was set for a decentralized Central Bank. The Fed has been blamed for every financial calamity since its inception including the crash of 1929, skyrocketing inflation, bursting of the tech bubble and the financial crisis. Some would like to see a return to the gold standard or a computer and model driven policy reacting to data inputs. In other words, put monetary policy on auto pilot.
Federal reserve officials have been running computer driven models for decades and to a large degree are influenced by the impartial output. Talk to any airline pilot who’s had to take over the controls of an aircraft on final approach because the autopilot malfunctioned. Human input is still a valuable commodity.
Even if the Fed path is 180 degrees off course and we stumble into another recession, it’s better than the precedent of a politicized Federal Reserve. Take the logic a step further. Imagine if you will a Federal Reserve that not only answers to the President but to Congress as well. Now that’s really “The Twilight Zone.”
