Trump, China Trade War Pressure the Fed to Cut Rates

Trump, China Trade War Pressure the Fed to Cut Rates

Trump, China Trade War Pressure the Fed to Cut Rates

As September 1 approaches, the pressure is mounting on Fed Chairman Jerome Powell to implement another interest rate cut after the last round of rate cuts in July. September 1 is the date when escalated tariffs on US and Chinese goods are expected to take effect.

These tariffs just intensified on August 28, after the Trump administration increased its tariffs on the remaining $300 billion worth of Chinese exports from 10% to 15%. These tariffs will be implemented in two phases:

• The first phase will impose a 15% tariff on $125 billion of Chinese imports effective September 1. This phase includes consumer goods like smartwatches, Bluetooth headphones, flat-panel TVs, and footwear.
• The second phase will levy a 15% tariff on the remaining $175 billion of Chinese imports effective December 15. This phase includes smartphones, laptop computers, game consoles, toys, and clothing.

On August 23, China announced retaliatory tariffs on $75 billion worth of US imports, which would become effective on September 1 and December 15. On August 29, China stated that it would not retaliate to the additional 5% tariff. China’s reaction sent the VanEck Vectors Semiconductor ETF (SMH) up more than 2%, and the SPDR S&P 500 ETF Trust (SPY) rose 0.9% in early trading on August 29.

The escalating trade war has raised fears of recession among fund managers and analysts. However, economic data doesn’t show any signs of recession so far. The stock market has been panicking on any trade war escalation and Fed rate cuts.

How the Fed rate cuts impact economic growth

Before we look at the differences between Trump and Powell, let’s see how the Federal Reserve uses interest rates to impact economic growth. The interest rate is a monetary policy tool that the Fed uses to control the money supply in the economy.

The Fed rate influences the interest rate banks charge each other on overnight reserve loans. When the Fed cuts interest rates to reduce financing costs, this action encourages borrowing and investing. This boosts the money supply and inflation, leading to economic growth.

During the financial crisis, the Fed reduced the interest rate to 0.25% in December 2008 and maintained this rate until December 2015. The Fed gradually increased the rate to 225 basis points in 2019, which is less than half the 525 basis-point level that existed before the 2008 crisis.

Until earlier this year, the Fed intended to hike interest rates twice this year. However, the Fed agreed to maintain a stable rate as the China trade war escalated. Concerns around global growth, inflation, and tariffs forced the Fed to cut interest rates.

After 10.5 years, the Fed cut the interest rate by 25 basis points on July 31. According to a July 31 CNBC report, Powell noted that he is loosening the monetary policy in light of economic situation resulting from the China trade war. Although he didn’t guarantee future cuts, he stated that the Fed is open to potential rate cuts if the economic outlook deteriorates further.

What does Trump want from the Fed?

Although July’s 25 basis point rate cut was in line with market expectations, it was lower than President Trump’s expectations. What Trump wanted to hear from Powell was that this is the beginning of a lengthy and aggressive rate-cutting cycle.

According to the July 31 CNBC report, Powell reiterated that the lengthy rate-cutting cycle “is not what we’re seeing now, that’s not our perspective now.” So, the stock market fell despite the rate cut.

As the trade war escalates with the new round of tariffs coming in September, Trump is putting increasing pressure on the Fed to cut interest rates. In an August 19 tweet, Trump wrote, “The Fed Rate, over a fairly short period of time, should be reduced by at least 100 basis points, with perhaps some quantitative easing as well. If that happened, our Economy would be even better, and the World Economy would be greatly and quickly enhanced-good for everyone!”

Trump believes that it’s not Chinese tariffs but the Fed that is slowing the US economy. During the August 22 Squawk on the Street program on CNBC,  Jim Cramer discussed the risk of recession. He stated, “The president is saying, ‘We’ll take it, we can handle it.’” Cramer noted, “It’s Powell’s job to keep us out.”

The Fed’s September meeting

The FOMC (Federal Open Market Committee) plans to meet on September 17–18 to determine the upcoming interest rate level. During the recent Jackson Hole conference, Powell underscored his pledge that the Fed would “act as appropriate” to support the economy.

The government and the Fed are divided over rate cuts. Economists expect a rate cut of 25 basis points while Trump is pushing for a rate cut of 50 basis points.

First published here: Trump, China Trade War Pressure the Fed to Cut Rates