Trump’s public spat with Powell helps no-one

The market did not like the Federal Reserve’s interest rate rise this week. Garry White takes a look at why.

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  1. Garry White

For central bankers, credibility really is everything. That’s why Donald Trump’s public attacks on Jerome Powell, chairman of the Federal Reserve, have been particularly unhelpful over the last few months. It’s important that there is at least an appearance that monetary policy is free from political interference, so President Trump’s social media attacks are almost certainly counterproductive. The Twitter comments make it less likely that Mr Powell will act in a way the President would like in order to maintain a modicum of credibility. The President should have picked up the phone and had a private conversation because, in this case, following the Presidential lead may be exactly what equities need.

The market reaction since the interest-rate announcement on Wednesday has demonstrated that stock market investors are more aligned with the views of President Trump than Mr Powell. US equity markets are on track to post their worst December performance since 1931 – the height of the Great Depression. The S&P 500 fell 14.5% in December 1931 and the Dow lost 17%.

Thankfully, markets are unlikely to top this record in 2018 – the S&P is currently down 9% and the Dow 8.6% in December so far. However, this performance is particularly disappointing, as the so-called Santa rally is a common feature at this time of year. The Dow has only fallen during December on 25 occasions since 1931 and, usually, December is the best month of the year for the S&P 500. This poor stock market performance has created a major worry for Donald Trump. The US President claimed ownership of the equity market gains when markets were hitting new highs – but this also means he has to own the falls too.

Because major US indices have fallen into correction territory and fears of falling growth next year have increased, the market wanted an even more dovish tone from the central bank than the one it delivered. Sure, the members of the rate-setting Federal Open Markets Committee (FOMC) indicated that there are likely to be just two rate rises in 2019 compared with its previously expected three – but it still hinted a further rate rise was expected in both 2020 and 2021. The central bank also noted that it would be keeping a keen eye on economic indicators, so future rate rises are data dependent. However, Mr Powell’s insistence that interest rates need to get to a more “normal” level is questionable. In the post-financial crisis world, what should be regarded as normal?

The interest rate sensitive parts of the US economy are already under pressure. US single-family home completions dropped for the third straight month in November, to their lowest level in more than a year. US vehicle sales are also tumbling – and this trend is expected to continue next year. Elsewhere, there are signs that business investment is cooling, another potential worry for the markets.  As well as rising interest rates, we also have a further squeeze on the world’s largest economy in the form of quantitative tightening. Under this programme, the central bank is trying to shrink its balance sheet by allowing its holdings to mature without replacing them. This takes money out of the financial system as the US Treasury finds new buyers for its debt.

So, Mr Powell finds himself in a difficult position. He knows that economic cycles usually come to an end because central bankers over-zealously tighten policy. Just one year into his role, he will not want to be the man that is blamed for the next US recession. However, central bank communication always involves a difficult balancing act and if the FOMC had made a sharp reversal of its course it may have spooked markets into believing things were worse than they seem.

It is also unfortunate that the Fed meeting overshadowed a positive development this week. Of the three major concerns for markets heading into 2019 – the Italian budget crisis, Trump’s trade war and central bank overtightening – one of these issues now appears solved. The European Commission and Italy reached an agreement over its 2019 budget and there will be no “excessive deficit procedure” that could have led to an EU fine – and potentially fuelled euro scepticism in Italy. Ironically we have the Gilets Jaune to thank for that, after President Macron’s concessions to try and end the dispute resulted in expectations that the French deficit will breach Eurozone rules. We do not know how the trade war will end, but President Trump surely must be realising he can’t have the equity gains he desires at the same time as pursuing a damaging trade war. This gives some hope that he will seek a resolution and declare a win sooner rather than later.

This leaves the Federal Reserve as an issue to keep investors awake at night. Perhaps the most important new part of the central bank’s statement this week was that it was also going to look at international indicators as well. This may turn out to be Mr Powell’s “get out of jail free card” that will allow him to become more dovish over the course of 2019 while still saving face. This could mean the battle between the Fed and the Oval Office will result in a victory for President Trump. Markets will be pleased if this turns out to be the case.

A version of this article appeared in Friday’s Daily Telegraph.

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