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Back and Forth with The Fed

Back and Forth with The Fed

The Fed Chair Jerome Powell and President Donald Trump have a long history of disagreements. The President’s view of the economy diverges greatly from the situation outlined by The Fed, meaning the country’s political leader has different expectations for its central bank than the bank itself. The ongoing back and forth between The White House and The Fed reached its peak when the President posted on Twitter that he couldn’t decide who the bigger enemy was: Fed Chair Powell or Chinese President Xi.

While a message like that doesn’t reflect the administration’s official position, it’s still a surprisingly harsh statement for the head of an institute that earned the trust of the financial markets over a hundred years ago. One of the preconditions to the Fed being able to fulfill its role as the central bank of the US is that it remains independent of any political obligations and bases it’s interest rate policy solely on the economy. Its primary purpose is to ensure a stable and predictable rate of inflation, which on occasion puts it at somewhat at odds with The President.

Back in July 2019 they decided to lower interest rates due to a sense of moderating inflation. The chair’s comments at the time suggested that the Fed’s experts were concerned about a possible slowdown of the US economy. While growth rates in 2017-2018 were at an astounding 3%, they declined to 1.1% in the last quarter of 2018 and rose to 2.1% in the second quarter of 2019. The Fed considered these figures to be a result of the government’s fiscal policy. The result was the highest growth rate of any developed country, dispelling any doubts about the country’s leading role in the global economy. The explosive economic growth was naturally followed by an expansion in the supply of money which also lead to a spike in inflation. Said spike forced to act and try to aim for a base interest rate level that doesn’t interfere with economic growth while still keeping inflation manageable. Some have suggested the recent tax cuts as the underlying reason for this new cycle of rate hikes.

The additional profits from the tax cuts increased confidence in US corporations, which combined with the 2.5% base interest rate led to a great deal of currency market interest in the dollar, especially at the expense of other low interest rate currencies. There were initially no practical downsides to the strengthening dollar, up until the US-China trade conflict. At that point China countered by deflating their currency to mitigate the effects.

The President’s response has been urging The Fed to weaken the dollar by lowering the base interest rates. Given how the two parties locked horns over how what they believe is best of the US economy, it’s worth taking a closer look at what were to happen if the Fed reduced the base interest rate by even just 1%. The first thing to happen would be a large scale sell-off of US dollars across the globe. One one hand that would definitely give the US an advantage in the trade war, however, at the same time it would also increase the cost of imported good, which would also increase inflation. Any potential gains would likely be completely wiped out by inflation. The last time The Fed slashed interest rates their reasoning was that they needed to offset the potential risk of the tariffs and the uncertain trade environment. It was intended to be a rare correction to their usually strategy rather than a completely new direction. Powell’s comments at the time suggested that he had no intentions of taking any actions that could weaken the dollar because from their perspective inflation is the greatest danger.

The Fed’s role is fundamentally a reactive one. Their decisions step-by-step responses to the Administration’s economic policy. The President on the other hand attempts to pro-actively pursue the agenda he believes will spur economic growth. It’s inevitable that the two would eventually come into conflict even if both have the best intentions. When each side is fully committed to it’s own reasoning and narrative, it’s up to you to decide who’s right.

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