The Trump – Powell Showdown: Independence or Allegiance?

Is Powell about to bring an end to the FED’s independence? There’s more than sustaining stock values in Wednesday’s testimony…
Bob Mason
Powell

The Stats

Independence Day celebrations were followed with a boost for the Dollar bulls on Friday. With nonfarm payrolls coming in at 224k in June, the timing couldn’t have been worse for those looking for a July rate cut.

The monthly NFP average for the first 6-months of the year stood at 180k. That’s with May’s 75k and February’s 20k NFP numbers.

On top of the NFP numbers, wage growth held steady at 3.2%, with the participation rate on the up to cause a 1 basis point increase in the unemployment rate.

When looking at the economic indicators, however, the manufacturing sector was crawling along at best. While the headline ISM survey PMI stood at 51.7, well above stagnation, new orders were unchanged. Backlogs contracted and supplier deliveries slowed, while employment was on the rise.

With the manufacturing sector continuing to struggle, the all-important service sector has also seen productivity growth on a downward trend. Accounting for around two-thirds of the U.S economy, the FED will likely be far more interested in the service sector numbers. The ISM non-manufacturing PMI pulled back from 56.9 to 55.1 in June. More importantly, the PMI is down from a post-global financial crisis high 61.6, reached in September of last year and is at its lowest level since July 2017’s 53.9.

To put it into perspective, however, the services sector last contracted in January 2010, which was in the wake of the global financial crisis. Since the global financial crisis, the PMI had only high 60 levels and above on 5 occasions, 3 of which were in September, October and November of last year.

Unsurprisingly, when considering the downward trend in the manufacturing sector, factory orders fell for the 3rd time in 5-months in May. In spite of the extended U.S – China trade war, the trade deficit also widened.

Taking the FED’s preferred Core PCE Price Index numbers, inflationary pressures have also softened, with the annual rate of inflation sitting at 1.6% in May.

The FED

When considering the current trend in the economic indicators, the only positive has been the NFP figures of late. Taking account of the U.S economic indicators tracked each week, the stats have been skewed to the negative for the last 7-weeks. The last time the stats were skewed to the positive was in the week ending 17th May.

That’s quite a stretch and certainly justifies the FED’s more dovish stance on policy. Perhaps there are enough doves sitting on the FOMC to push through a rate cut this month.

The U.S President is unlikely to back down from the extended U.S – China trade war. The markets and central banks have blamed the trade war for the slowdown in global economic growth. That suggests that there’s more pain to come.

An unknown, from a FED perspective, is how much longer the trade war will wage on for. We can speculate that Trump would want a deal to be in place well before the presidential election in November 2020. We can also speculate the Trump would want to avoid a U.S recession between now and November of next year. It’s not entirely surprising that the U.S President is placing greater pressure on the FED to make a move.

The reality is, however, that it is for this reason, amongst others, that the FED must remain impartial and uninfluenced by the U.S administration.

So, with the markets now looking ahead to FED Chair Powell’s testimony to Congress this Wednesday, what can we expect?

Lawmakers will have the opportunity to grill the FED Chair and a grilling it will be. That won’t be a bad thing for the financial markets, however. Powell will need to spell out whether a rate cut is imminent and, if not in July, then when?

The Projections

The other uncertainty is how aggressively the FED will be looking to cut rates. Economists have forecasted the U.S economy to grow by 2% in the 2nd quarter. That’s some way off 4.2% growth in the 2nd quarter of last year and 3.1% growth in the 2nd quarter of 2017.

Based on the June FOMC economic projections, the median was for the FFR to sit at 2.4% in 2019. The central tendency stood between 1.9% and 2.4%. Perhaps more significant was the fact the FOMC left projections unrevised from the March meeting. This was in spite of the softer economic numbers. The median and central tendency projections point to a hold on rates through this year…

For the Dollar and the Equity Markets

It’s perhaps incredible to consider the markets to have priced in a July rate cut. There is plenty of uncertainty. And then there are the FOMC June economic projections.

Trump has likely led the markets to price in a July rate cut, rather than dovish FOMC members. It will be quite easy for the U.S President to blame the FED for any sell-off in the equity markets…

It’s been some time since so much has hinged on FED Chair testimony to Congress. Ironically, Powell is speaking ahead of the FOMC meeting minutes due out later in the day. The minutes would have taken center stage.

The markets believe that the FED has no choice but to cut rates. Any suggestion of a wait-and-see will likely send the equity markets into a tailspin. Powell could, however, talk of a willingness to support. That buys a little more time. It avoids writing off the chances of a rate cut completely. It also gives the FED Chair the opportunity to digest a slew of June data. Inflation numbers (11th July), June retail sales figures (16th July), the 2nd quarter GDP figures (19th July) and the FED’s preferred Core PCE Price Index numbers (30th July) are all due out in the coming weeks.

Perhaps the real question is whether a rate cut would have any material impact on business investment. Businesses are unlikely to loosen the purse strings as the U.S and China continue to battle it out…

The outcome of this week’s testimony will be significant. The FED will either reaffirm its independence or bring into question its impartiality. Impartiality that it had fought so hard to attain… The markets, well, both the Dollar and the equity markets will make their feelings known.

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