This Powell guy just doesn’t seem to get it…
I can remember the statement like it was yesterday. It was late September 2018, and I was in Las Vegas, Nevada, for a work conference. Every year, the company I worked for invited financial personalities to present their thoughts and ideas to our subscribers. I would interview the presenters afterward, getting their take on the markets.
At the time, I was sitting next to one of my co-workers and friend, Greg Diamond. He is a former hedge fund trader and portfolio manager whose specialty was options and futures investing. The two of us enjoyed discussing the underlying drivers of the stock market’s direction.
Earlier that month, then President Donald Trump announced he would place a 10% tariff on $200 billion worth of Chinese imports. The duty would ratchet up to 25% at the start of 2019 unless China met the White House’s trade terms. The announcement was part of an escalating trade fight that was taking place.
That particular afternoon, newly appointed Federal Reserve Chairman Jerome Powell was speaking. Our central bank was tightening rates. Greg and I were discussing investors’ anxieties due to the escalating trade tensions combined with rising borrowing costs. Wall Street was worried the economy was about to collapse.
Then Powell dropped the hammer. He said the Fed was dead set on raising interest rates no matter what Trump’s plans were. Greg’s reply was, “This Powell guy just doesn’t seem to get it!”
At that moment, we both agreed that fund managers were about to teach the Fed chair a very painful lesson. The central bank shouldn’t be raising rates… it should be lowering them. A few days later, the sell-off started. It wasn’t until three months and 20% later, that Powell finally caught on.
Earlier this week, we experienced echoes of what happened back then. President-elect Trump has been vocal about his intentions to introduce new tariffs on China and potentially other trading partners. Yet, the Federal Reserve reduced its rate cut guidance for next year, at a time when the economy may need it. Now the announcement isn’t the same as raising rates into the face of a trade fight, but Powell should head this week’s warning shot from investors.
But don’t take my word for it, let’s look at what happened in 2018…
Prior to be elected for his first term as president, Trump expressed concerns about the unfair treatment of America by its trading partners. He said deficits ran too high and domestic jobs were being shipped overseas. But he was especially worried about the intellectual property theft he saw taking in China. He felt the government-backed businesses there were stealing American innovation and cash in by selling cheaper products. So, he vowed to do something about it when he got into office.
Over the course of Trump’s first year in office, the rhetoric and warnings to Beijing slowly ramped up… if China didn’t change its ways, and treat us more fairly in trade, the U.S. would take action. Then by the start of 2018, the White House decided to get in motion. It placed duties on solar panels made outside of the U.S. The largest producer just so happened to be China.
The new tariffs came slowly and steadily. Next it was washing machines and then it was steel. But by March of 2018, the White House turned the dial up even more. Trump announced $50 billion worth of tariffs on Chinese goods. He cited intellectual property theft as the driver. The Dow Jones Industrial Average dropped nearly 3%.
At the same time, the Fed was trying to reload its tool box for the next economic downturn. Powell said rates were the last piece of the puzzle yet to return to normal levels following the financial crisis of 2008-09. So, it intended to raise rates by 25 basis points each quarter throughout the year. It was targeting 2.5%.
Well, China wasn’t interested. It returned the favor by announcing tariffs of its own. It introduced a 25% duty on a number of U.S. based goods, including soybeans, the number one American export to China.
The U.S. responded by saying it would introduce another $100 billion in tariffs on Chinese goods. China cancelled soybean imports, The White House produced a list of goods to receive 25% tariffs. China didn’t cave. The tensions kept ratcheting up.
However, all throughout this time, investors could stomach the battle. The economy wasn’t in a freefall and corporate earnings were holding up. From the end of March through the end of September, the S&P 500 Index rallied over 11%. But investors were increasingly anxious about the economy. They knew Trump wouldn’t back off, so the ball was in Powell’s court. He had to back off or run the risk of crushing the economy.
Then, in early October the dam burst. Powell’s statement of pushing forward with rate hikes was the final blow. Until the central bank changed its tune, stocks wouldn’t get out of the penalty box. The S&P 500 lost almost 20% between the start of October and late December.
And Finally, Powell got the message. In late December he signaled central bank planned to back off its tightening bias. And by January of the following year, he said policy would be more flexible and it was in no hurry to raise rates.
So, here we are today. The U.S. looks to be on the verge of another potential tariff escalation with China. The Congressional Budget Office has recently warned that such an outcome will hurt economic growth. This development happened on the same day as the Fed decided to dial back its rate cut outlook for next year.
Now, while raising rates and lowering rates have two very different consequences… the former is removing money from the financial system while the latter is adding it. And, our economy is still in very good shape. That tells me that under those conditions the stock market can continue to power higher.
But investors are still sending Powell a warning shot. They’re telling him and the other members of the rate-setting Federal Open Market Committee that changing the course on interest rates now would be a huge mistake. Because, if we do enter a trade fight, rate cuts will be needed to dig our way out, not rate hikes.
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