Economic Commentaries


To say that relations between the Federal Reserve and the administration are strained is an understatement. This is despite the fact that the Chairman and several Board governors are administration appointees. We are certain there was never any quid pro quo in these selections. We are sympathetic to the administration's criticism, but we are opposed to displays of animosity.

Monetary policy actions have played a role in financial market turbulence and the beginnings of noticeable economic weaknesses. But equally if not more important are simmering trade tensions and a heightened sense of chaos within the White House. We will not comment on the last item but the other two deserve some scrutiny. From our vantage point economic growth peaked in the first quarter of 2018 as the housing market began to reel from rising interest rates and a misguided tax overhaul. Additionally global trade flows began to contract as fear of supply chain disruption surfaced; tariffs were openly discussed and threatened; and a fundamental sclerosis became visible across Europe. On again off again Brexit headlines have not helped.

Since the spring we have warned that the Fed's two pronged strategy of raising interest rates and contracting the balance sheet would be too much for a still fragile U.S. and global economy to absorb. From its verbiage it seemed obvious the Fed never bought into the idea that tax cuts and deregulation could foster a step up in growth without inflation. But a step up in growth is necessary if a soon to be uncontrollable federal budget deficit is ever to be reined in. Meanwhile, inflation has yet to assert itself and if economic conditions continue deteriorating, inflation pressures will remain dormant.

Inflation never appeared and by tightening credit too aggressively a continuation of stepped up growth is being seriously threatened. So it is understandable that the administration is miffed. But it is not too late to correct past errors in our view. Were the Fed to strongly signal a halt to interest rate increases and/or pare back its balance sheet reduction schedule, liquidity would quickly flow back to the economy. Mortgage rates would stabilize or fall and our guess is that the dollar index would begin losing some of its luster. This would stabilize commodity prices, support emerging markets, and presumably calm capital markets which are currently paranoid over an onslaught of corporate debt rollover this year.

But monetary policy adjustment is not enough. The U.S. must live up to its promise to remove tariffs on Mexican and Canadian imports. It needs to stop threatening tariffs on goods flowing from Europe. And most important it needs to curtail its proclivity for increasing and expanding tariffs on all things flowing from China. The conclusion of a trade deal or more realistically the outline of a trade deal with China is crucial in order reignite executive decision making.

Everyone seems to have turned cautious on the U.S. and global economy and on financial markets. In some sense we are gratified that many forecasters are lowering growth estimates toward our 2% forecast. Ironically though, we are poised to raise our forecast back to 2.5% to 3% assuming policy makers quickly get religion. In this vein Chair Powell's recent remarks are encouraging. But if there is no follow through, a growth slowdown to 2% is likely to prove too optimistic.

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