Trump’s trade war could mess up the Fed’s plans
The Federal Reserve is widely expected to raise interest rates on Wednesday for the second time this year. But its plans going forward have been thrown into confusion thanks to President Donald Trump.
Trump is waging a trade war on multiple fronts, which could raise prices for American companies and consumers and slow economic growth. It has already put a dent in business confidence in the economy, according to a survey of the nation’s top CEOs. And if that becomes a drag on growth, the Fed could put the brakes on its interest rate hikes.
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But Trump’s pro-growth policies also present risks: New tax cuts and government spending could kick the healthy economy into overdrive, requiring the Fed to raise rates more quickly, potentially choking the near-record-long expansion.
Both dangers complicate the central bank’s efforts to maintain a Goldilocks economy — not too hot or cold, but growing at a sustainable rate.
For now, fiscal policy looms larger in the Fed’s calculations, Michael Feroli, chief economist at JPMorgan Chase, told reporters Monday.
“That’s an actuality, whereas the trade policy is still a risk,” Feroli said. “If trade news deteriorates, and you start to see that show up in [economic] activity, I think the Fed would have to reconsider.”
Central bank policymakers are on track to raise interest rates Wednesday for the seventh time since December 2015. It’s part of an effort to gently remove the historic levels of support for the U.S. economy in the aftermath of the 2008 financial crisis as growth continues to build momentum.
Markets will be watching closely to see whether the Fed signals one or two additional hikes this year, a decision that will be driven in part by the predicted ripple effects of recent actions by Congress and the president.
Fed officials have emphasized that they’re unsure how to judge the longer-term effects of tax cuts and new government spending, since fiscal stimulus is usually deployed when economic growth is lagging. Right now, unemployment is at 3.8 percent with inflation hovering right around the Fed’s 2 percent target.
“It makes the Fed’s job more difficult all around because what you’re getting is a stimulus at the very wrong moment,” former Fed Chairman Ben Bernanke said at an American Enterprise Institute event last week. “The economy is already at full employment.”
The stimulus will also lose steam in 2020, he said. “Wile E. Coyote is going to go off the cliff,” Bernanke said, in reference to the cartoon character who was able to defy gravity until he noticed there was no longer ground beneath him. “He’s going to look down, and that’ll be essentially withdrawn at that point.”
Following the new tax law, H.R. 1 (115), and government spending package, the Fed boosted its projections for U.S. GDP growth to 2.7 percent this year and 2.4 percent in 2019.
Fed Chairman Jerome Powell told reporters in March that central bank officials generally expect the stimulus to boost spending for “at least the next, let’s say, three years,” while lower corporate taxes could drive increased investment. “It’s uncertain, though,” he added.
The central bank faces a balancing act to avoid becoming the cause of a recession. If it raises interest rates too quickly, without being warranted by strong GDP growth, it could strangle the economy.
But if it doesn’t raise rates fast enough, that could spur out-of-control inflation, which would lead the Fed to raise rates even more rapidly — possibly triggering a recession.