The National - News

Uncertaint­ies surroundin­g Trump are overshadow­ing Fed’s economic optimism

- TIM FOX Tim Fox is group chief economist and head of research at Emirates NBD

While the Federal Reserve continued on its course of monetary policy normalisat­ion last week, reflecting the current strength of the US economy, other forces were building that might eventually threaten it. Trade tensions were first among these, but there were other scattered events that concern markets. The week ended with further steep losses in equity markets following those seen in February, making investors question whether such falls are merely a correction or something more fundamenta­l to be worried about.

The Fed’s sixth interest rate hike in the current cycle came as the US economy appears to be in such robust health that few in the market doubted the wisdom of it. The Fed raised its rate band 25 basis points to 1.50 per cent – 1.75 per cent in a unanimous decision, and retained the dot plot at three hikes for this year. However, the median projection was only a fraction away from rising to four, and the dot plot for 2019 was raised to from two hikes to three.

Furthermor­e, the Federal Open Market Committee looks to tighten monetary policy through to the end of 2020, lifting the rate at the end of that year to 3.4 per cent, from 3.1 per cent previously. The Fed’s statement introduced the view that “the economic outlook has strengthen­ed in recent months”, and highlighte­d that job gains have been strong. The change in the statement accompanie­d hikes in the GDP estimates and downward revisions in the unemployme­nt rate forecasts.

Fed chairman Jerome Powell was asked about the potential for a trade war and the impact this might have on the Fed’s forecasts, but while he acknowledg­ed the risks of retaliatio­n to recent US trade measures, he did not see these affecting the economic outlook yet. That was, however, before the Trump administra­tion imposed further tariffs on up to $60 billion of Chinese imports, which in turn saw China respond with $3bn of its own tariffs on 128 US products. Although relatively modest, the Chinese response was to the earlier aluminium and steel tariffs with further measures still awaited in reaction to the latest ones.

Such actions do not yet amount to an all-out trade war, but they do provide an early warning about how a delicate situation might easily unravel, especially with an impulsive and inexperien­ced US president now increasing­ly following his own instincts over key issues such as trade and national security. In the two days following the hike in interest rates, as well as firing off another trade tariffs salvo, Mr Trump replaced his national security adviser with a notorious foreign policy hawk, whose reputation is for confrontat­ion rather than for solving geopolitic­al situations diplomatic­ally.

Mr Trump also unexpected­ly threatened to veto a $1.3 trillion spending bill that could have closed down the government again for the third time this year, only to change his mind at the last minute.

Instabilit­y was also evident closer to home with a prominent resignatio­n from the Trump legal team that is defending the president against the ongoing Mueller enquiry. This enquiry is also taking in more casualties, and not only individual­s.

Facebook has sold off on the back of revelation­s exposed by the ongoing investigat­ion causing the tech sector more generally to lose ground, a sector that had been a market leader in the bull market.

At the end of the week, the Dow and the S&P 500 had suffered their biggest weekly drops in two years, having fallen back to levels seen around the time of the volatility-induced February “correction”. These losses could hardly be put down to any serious apprehensi­on that the Fed will follow through on its hawkish forecasts, as bond yields also lost ground suggesting that fixed-income traders do not believe that interest rates are going to double by the end of 2020. The dollar also found itself weaker as a result.

More worrying is that as the Fed raised interest rates for the sixth time since 2015, the markets do not appear to buy its optimism about the future, but rather they are seeing the seeds of the next downturn in the trade.

The markets do not appear to buy its optimism, but rather they are seeing the seeds of the next downturn in the trade

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