Fed Policy, Treasuries and Tariffs

The stock market should continue to be subject to developments in the tariff situation, including commentary about the tariffs' impact in corporate earnings reports.  Although Fed monetary policy is now on hold, officials too will be focused on the potential drag on economic activity and boost to inflation from tariffs.  Besides Fed policy, the risk of massive selling of longer-term Treasury securities is not independent of tariff developments.  In the background, Trump's attack on Powell could develop into a big problem for financial markets.

Fed Chair Powell commented last week on the framework the Fed will use to decide on monetary policy once it sees effects of the tariffs.  He said whether to tighten or ease will depend on how far each of its mandated targets -- unemployment and inflation -- is from its goal and how much time each would be expected to take to return to goal.  Presumably, policy would be focused more on the target that is slower to return.  Powell said the tariffs may push the targets away from their goals for the "balance of the year."  He also underlined the importance of restraining inflation expectations.  Currently, the Fed is in no hurry to change policy.  As I mentioned last week, the optimal solution to this quandary is to let the unemployment rate rise at first and then ease policy.  This would allow the economy to recover without putting upward pressure on wage inflation. 

Powell did not discuss whether loss of confidence in the US will result in massive selling of Treasury securities, most likely because it is not in the Fed's purview.  However, it remains a potential problem for stocks and the economy.  The possibility of significant confidence loss is not independent of tariff policy.   On the one hand, a winding down of the tariff issue, perhaps by Trump's paring down the size of tariffs for those countries with which there is successful negotiations, could restore confidence in the US and end the dumping of Treasuries.  This would likely result in a decline in longer-term Treasury yields and stronger dollar -- a double positive for the stock market.  On the other hand, a worsening in the tariff situation could prompt greater loss in confidence and more Treasury/dollar selling -- a double negative for stocks. 

Trump's complaint that the Fed should ease and that Powell should be fired would probably backfire if carried out.  Both would be viewed as /1/ inflationary and /2/ undermining Fed independence.  They would result in higher longer-term yields and weaker dollar -- negatives for the stock market.  Trump cannot legally remove Powell as Fed Chair while his term lasts through May 2026.  This, however, may not stop Trump from trying, as his staff is reported to be looking into how he might be able to fire Powell.  A soft Q125 GDP report, due April 30, could raise the pitch of Trump's tirade.  His attack on Powell appears to be an attempt to shift the blame for the financial market sell-offs and economic slowdown to the Fed from tariffs.