Trump's Beef With the Fed and "Order" Re China

Trump's public beef with the Fed is reprehensible -- political interference with a central bank is bad for the latter's credibility and the economy.  Nevertheless, there are a couple of important issues that may have motivated his outbursts.   First, is Trump right that more aggressive Fed stimulus (i.e., 50 BP cut) is needed to offset negative fall-out from his fight with China.  The trade-off between short-term pain and long-term gain would be mitigated.  And, stronger US economic growth could give him more leverage against China by giving him additional time to press his case.  Second and more basic, is he right in thinking the Fed is incorrect believing that 3.0% growth would exceed the economy's long-run potential growth rate and be inflationary.

Is Trump right on these two issues?  As for the first, aggressive easing offset to the negative fall-out from the trade war is not now needed because Real GDP Growth is still exceeding its estimated long-run potential pace, if the Fed is correct about the latter pace being 1.8-2.0%.  Although Powell and the Fed moved toward Trump's demands by citing downside risks in the outlook and cutting the funds rate by 25 BPs in July, the subsequent dissent against further easing by some FOMC members stems from the still strong growth rate.  Trump's more basic argument for aggressive Fed easing comes down to a belief that the Fed is too conservative in its 2% view of what is sustainable non-inflationary growth.  Whether core inflation picks up or not will determine who is right.

The question of what GDP Growth Rate is sustainable and non-inflationary may take time to get resolved.  The latest evidence throws doubt on Trump's belief that the Fed is aiming for too low a growth rate.  The Core CPI has risen an above-trend 0.3% m/m in the past two months.  And, Compensation/Hour --the broadest measure of labor costs -- sped up sharply in H119.  The tight labor market may be finally exerting upward pressure on labor costs, and Powell should not have been so quick to agree that the Phillips Curve is dead in his Semi-Annual Monetary Policy Testimony. 

Not all factors point to an inflation speedup ahead, however.  The dollar has continues to strengthen, which, along with weaker economic growth abroad, should hold down import prices -- although the tariffs should boost some prices.  And, lower oil prices should feed through to items like airline fares.   Which factors will dominate should become clearer this Fall.

The next important inflation report is the July Core PCE Deflator this coming Friday.  Consensus looks for +0.2% m/m and an increase in the y/y to 1.7% from 1.6%.  Both the m/m and y/y risk being 0.1% pt higher.  Calendar considerations raise the risk of a high 0.3% m/m increase in August Average Hourly Earnings, due September 6.

This week's US economic data will bear on the risks the Fed sees in the outlook.  The consensus estimates argue that the fall-out from the downside risks is limited and overall economic growth still is good.  July Durable Goods Orders, on Monday, will show whether the June bounce in Ex Transportation Orders is sustained.  Consensus believes that it will, as it looks for +0.1% m/m.  The August Consumer Confidence Index, on Tuesday, should reaffirm a strong consumer.   Although consensus looks for a decline to 130.0 from 135.7 in July, the level would be high.  The Claims data are expected to give back some of the prior week's declines.  But, they would remain in their recent range.

Trump's explosive "order" for US companies to rethink their operations in China would appear to reflect frustration that the Chinese are not bending on the fundamental issue in the negotiations, namely for China to play by Western rules.  Trump's prior tariff imposition was meant to push China to acquiesce on this issue.  China's response by imposing 10% tariffs on some US goods shows it does not want to tackle this fundamental issue.  The 10% tariff is minor and a parry in the fight.   While Trump's "order" was ridiculed by some, it is in line with what may be the ultimate outcome of this battle -- a separation of two spheres of influence.  Or, perhaps fear of such separation could eventually persuade the Chinese to come to grips with more significant changes to their business practices.