In moments of chaos, set the thinking thermostat on ice-cold. Try to find the center of probability ahead, no wild swings. Put wishes aside. No prisoners.
Credit markets watch the Fed — and the economy, because that’s what the Fed watches. last week I thought we knew this week’s risks if not the outcomes: the Fed meeting on Wednesday, economic data today.
Hah. Mr. Trump’s tariff surprise on Thursday blew all of that to flinders. And it’s not over, market and economic reactions to new tariffs just beginning.
In the 24 hours since the new tariff announcement the 10-year T-note has fallen from 2.04% to 1.86%, and low-fee mortgages below 4.00%. The Dow has lost only 800 points so far, a victory. After the Fed rate cut the Fed-sensitive 2-year T-note rose slightly to 1.90%, but now traders expect deeper cuts from the Fed solely because of new tariffs, 2s to 1.73%.
Powell insisted that Wednesday’s .25% cut was a mid-course correction, not a trend. Two Fed voters dissented, one the demented vote of the KC Fed which always wants tighter policy and has always been wrong. But the second one, Eric Rosengren of the Boston Fed accompanied by his vehement press release reflected at least four other top officials who have indicated opposition to cuts. The Open market Committee seems to have gone along with the cut desired by doves and overseas worriers for the sake of solidarity (not for Mr. Trump — don’t even consider that thought). The post-meeting Fed statement, under Powell a shortened model of clarity was on Wednesday a redundant blob.
Powell does not have a majority with him — for anything. Not because of poor leadership, or an internal rebellion last seen thirty years ago. Nobody knows what to do with this situation, partly because we have not seen punitive tariffs in ninety years (Smoot-Hawley 1930), and mostly because the situation is crazy.
The new tariff elbowed new economic data from view — too bad, because those reports were the only source of calm. There is some small US slowing underway in some sectors, but all is well here. Here, not overseas, as Powell emphasized repeatedly. Jobs are fine, housing is fine, and consumers are fine. Construction spending is shaky for some reason (certainly not a shortage of credit), and the manufacturing purchasing managers July survey slid to a three-year low, perhaps a foreshock of what’s coming from the outside.
Did the Fed know of tariffs ahead of time? Powell on Wednesday: “…Trade policy tensions nearly boiled over in May and June, but now appear to have returned to a simmer.” No clue. And no opinion: “We play no role whatsoever in assessing or evaluating trade policies other than as trade policy uncertainty has an effect on the U.S. economy….” The Fed is silent, Republicans in Congress are silent, and so craziness continues and controls.
Conspiracy theorists are having a blast with this one: did Mr. Trump time the tariff announcement immediately after the Fed meeting on purpose, designed to force the Fed into deeper cuts? Whether he did or not, stick with crazy. There’s no predicting that.
The top economic official in the White House, Larry Kudlow, who in his entire previous fifty-year political life opposed tariffs this morning said “A lot of things can happen” before the September 1 effective date. The White House then emphasized that the tariffs will happen. Kudlow also said the effects of tariffs on the US are “miniscule.” Markets disagree.
Mr. Trump either does not understand tariffs or prefers his rhetoric. He says, “Tariffs are a tax on China.” No, not at all. The US importer of any product subject to tariff pays the tariff. The exporter may be able to reduce its price to offset the tariff, or the importer may reduce its margin over total cost and hold price to US consumers. If neither, the importer must pass on the tariff to consumers, who may resist by buying something else or not at all; and if so the importer stops importing.
In an old world of sailing ships, tariffs “protected” native businesses from import competition. In a light-speed IT world, acutely competitive, margins already under fierce pressure, and global supply chains interwoven and instantly adjusting to costs, a tariff imposed on one exporter beyond its ability to cut price puts it out of business. China
deserves some of that punishment, but not the exporters to China whose products are components of China’s exports, often re-exports of US exports to China.
That supply-chain crack-up is wrecking the greatest economic, wealth, job, and income boon in the history of commerce. Put a China exporter out of business, and the supply chain behind it enters a fantastic succession of rear-end collisions all over the world. Overseas effects of the new tariffs? The German 10-year has plunged to minus-0.494% today, and for the first time ever its 30-year bond has gone negative.
China will not kneel, especially not with Hong Kong rejecting the Party’s version of China. Pushing China harder is more likely to embolden its own hardliners.
As a US consumer of mortgage credit, how to play this? Don’t. If a refi makes sense, do it. Buy the house and give thanks for a lower rate. Investor? Bet on the long run. It’s crazy right now but not forever. Don’t try to outsmart crazy. If overseas trouble washes ashore here, the US will adapt faster than anyplace else.
Another economic risk: craziness undermines risk-taking. Craziness is a risk in itself. There is no way to estimate that effect. Tariffs or no tariffs there is plenty of money to be made, and business will continue to run risks. Dampened, maybe, but not stalled.
Of course there’s a worst case, a spiraling down of business activity spreading to loss of jobs and consumer demand, and no bottom to US rates. But odds are bigger that crazy passes like the fever it is.
One reason to watch the bond market: cause and effect are often very clear. The 2-year was not happy with Powell’s caution about future cuts on Wednesday, and reversed instantly on tariff news:
The 10-year did not care much about Powell, not expecting more cuts in the near term as had 2s. But 10s cared every bit as much about long-term damage:
GDP has slowed some as fiscal and tax stimulus has waned, but 2% is just fine, thanks:
The ECRI formulae are troubled by the negative yield curve, but their forecast has gradually improved all year long: