Now what for the Fed and markets?
Too many investors and market "professionals" are missing the point
I apologize in advance that this note isn’t particularly uplifting…
The Fed is pretty stuck here. They fear inflation from tariffs BUT they have to know that it’s not a form of inflation they’re likely to be able to impact by raising (or not cutting) rates.
They really can’t cut now, partly because of that and partly because they won’t want to look like they can be pressured by a president. A president who made another huge mistake by threatening to fire Fed Chair Jerome Powell. For the record, I’m no fan of Powell and I’m not here to defend him. He’s been wrong and late a LOT; Trump has at least that part right, though I can’t remember the last time the Fed wasn’t behind the curve. But if the market thinks there’s any chance of Powell being fired, they’d have to assume that the next step would be for Trump to install a rate-cutting sycophant. The result of which would be a spike in long-term yields due to fear of insufficient attention to controlling inflation. And stock markets will drop another 5% in just one or two days. That’s why someone told Trump to reassure the markets that he won’t fire Powell, which he did yesterday.
I sold another 10% of my stock holdings last Monday and I hope it turns out to be something I regret.
There’s way too much talk about “fair value” and US earnings and not nearly enough talk about 1) large foreign investors like pension funds and governments repatriating money out of US assets and into their own countries’ assets and 2) the potential, even if it seems unlikely with a big spender like Trump, for the federal government to cut (or at least not grow) spending and to shrink the deficit a bit (though they won’t get anywhere close to balance.)
For example, I think this Opco analyst is way too optimistic: This is why Oppenheimer is still bullish on U.S. equities amid recent volatility | Seeking Alpha
Again, I hope he’s right and I’m wrong.
All the usual stuff that people took for granted for the last 20+ years so they could just talk about earnings and Moore’s Law and the “Fed put” and low rates and AI cannot be taken for granted anymore. I don’t think the sell-off is done and when it is done, for the first time in my life I’d probably rather buy stocks in other countries.
America seems in the mood to oscillate between left-wing idiots and MAGA zealots when it comes to electing presidents. Well, it’s been the same MAGA president twice, after two left-wingers (Obama and Biden) and Trump’s defeating arguably the dumbest Democratic candidate of all in Kamala Harris. What we used to think of as “normal” for both Dems and Republicans is quite out of favor right now both within the parties and among much of the electorate. And frankly both parties have earned that distrust. Americans believe with good reason that the parties work for the parties; if the country gets something good out of it, it’s just a happy coincidence.
But if Trump doesn’t slam on the brakes on the trade wars, we will look back on a Trump presidency and say that at least as far as the economy and investments go, a Harris presidency might have been better. Again, someone got him to recognize that he’s causing real economic harm including to his base which then got him to make some happy sounds yesterday evening about negotiating with China but it’s within a bigger context of continuing to expound nonsense. Perhaps this had something to do with his slight tone-change: Trump softens tariff tone amid empty shelves warning, market slump (Axios)
Those who listened to my show before the election heard me describe — since I’m a nerd — two graphs that I thought represented the possible outcomes of a Trump and a Harris presidency. The X-axis represents how good the overall outcome for the nation would be and the Y-axis represents the probability of any given outcome along the X-axis. Harris was a tall skinny bell curve centered a bit to the left of zero, meaning a high probability of a slightly or moderately bad outcome and low probability of a good outcome or a disaster. My graph for Trump was almost a flat line, maybe a slight downward tilt on the far-right end, meaning a roughly equal chance of any outcome from utter disaster to moderately good, and then a lower chance of an incredible outcome but still above Harris’s chance of that.
In short, Trump had both more potential upside and more potential downside than Harris, though in my estimation extremely bad was more likely than extremely good.
So far, my description of Trump seems on-target. Indeed, while it’s still too early to say whether his presidency will end up being seen as a failure or as a success I think he has already ensured that the best possible outcome is moderate success; great success is now impossible, even though I’m well aware that his minions will very much disagree.
My take is not based on a personal dislike for Trump (which doesn’t mean I like him, but rather than I’m not letting it color my analysis.) It’s based on an honest assessment of the damage that Trump has already done to the desirability and reliability of the US as a trading partner, customer, supplier, or ally.
It’s ironic and tragic that a man whose brand is strength is doing more to weaken the country than anyone since at least Jimmy Carter and maybe since Herbert Hoover. And he’s as utterly clueless about the impacts of his policies as those two were. Actually I think Hoover is a better comparison than Carter but Carter is the most recent example of someone who diminished the global reputation of the US and the economy at the same time.
There’s only one half-decent way out of this…and half-decent is as good as it can get because so much damage is done that cannot be undone anytime soon, and definitely not while Trump or anyone like Trump is president. The almost-graceful exit would be to pretend that the actual goal the whole time was negotiating leverage. Sign whatever agreements you can get, even if they are barely improvements over current deals, and call yourself the world’s greatest negotiator. Repeal even the 10% tariffs or at least lower them to 5% which is still stupid but at least probably not suicidal. Like taking small survivable doses of poison rather than a fatal dose. Like I said: still stupid. But I don’t think Trump will go along with that. He is too deeply committed to tariffs. He sees them and what he expects to be their results as his legacy.
Trump should normalize trade with everyone except China by doing the best and quickest negotiations possible (but does he have the staff or talent on hand to put out so many fires — fires he started — at the same time?) and do something to get trade with China back at least far enough that we can import things we cannot get elsewhere while also encouraging the production of those things domestically or by allies so that we can reduce and then eliminate dependence on China.
Autarky is a self-destructive goal chased by the economically ignorant.
Understanding Autarky With Real-World Examples (Investopedia)
In the meantime, the best thing the Fed can do is nothing.
p.s. Here’s my worst-case scenario and I can’t tell you how much I hope it doens’t happen. This is not a prediction; it’s a fairly low probability story but it’s not impossible:
Trade wars cause recession
Economic weakness causes Trump to call for stimulus
Spineless Republicans and always-willing big-spending Democrats go along and pass a big spending/stimulus bill that Trump makes clear he’ll sign despite warnings from the Fed
Long-term interest rates spike but the dollar doesn’t go up with them as is usually the case because foreigners now don’t want our debt
The Treasury warns of trouble rolling over US debt and tells Congress they must find a way to dramatically cut federal spending
Interest rates go up more and stocks go down more
The economy tanks, led by a reverse wealth effect from declining housing prices
Democrats sweep elections across the country promising to solve the problem by raising taxes on the rich
Stocks go down more
America suffers a lost decade due to a combination of spineless politicians who may know better and bold politicians who are idiots, including the AOC/Sanders wing and the Trump/Vance/Navarro wing.