Normally, in a week that includes Congressional testimony by that Fed chair, the event would be all-consuming for market watchers and participants, and the focus would be entirely on any hints regarding policy.
America, however, gave up on “normal” on January 20, 2017, so while Jay Powell’s appearance on the hill this week will be closely watched, the bulk of the interest will be on a much more personal level: The financial world will be looking to see to what extent Powell stands up to the bullying currently coming from the White House.
Make no mistake, what we have heard from Donald Trump over the last few months is bullying, or at least an attempt at it. Before we get carried away though, it should be pointed out that it's not that unusual: It has long been said that the President has a “bully pulpit” from which public pronouncements are often made with the intent of influencing policy.
Even the fact that this involves something heretofore regarded by the market as sacrosanct -- the independence of the Fed -- is not really that big a deal. Trump is far from first to attempt to erode that independence, nor will he be the last.
What is different this time around is the motivation.
As he himself frequently points out, the economy is doing well. We have good GDP growth and unemployment is at its lowest in half a century, and that combination finally looks to be forcing wages higher. That, remarkably, is being done without causing any noticeable increase in inflation. And, as I’m sure you are aware, the stock market keeps hitting new highs.
In those circumstances, the only logical course of action is to leave things as they are. So far, the collective wisdom of the Fed board, in all its various iterations since the recession, has proven to be, if not perfect, at least pretty good. When they started QE and moved to a zero-interest-rate policy, we were told it would lead to higher inflation.
Then when they ended and reversed QE, and again when they started to increase rates, we were told that that would plunge us back into recession.
Yet here we are, with what Trump frequently describes as the “best economy ever.”
Of course, a good track record so far doesn’t make the Fed infallible. One could argue that given the ongoing trade war, the last rate hike could, at some point in the future, prove to be a mistake. If that is true though, it would be the trade war, not the incremental twenty-five basis points, that really did the damage. The President would be better off focusing on a resolution to that conflict than creating another one. Unless, of course, the conflict was not a bug, but a feature.
When bullies steal a kid’s lunch money, it is not because they need the money. Playground bullying is usually about power, and this bout of Presidential bullying is the same. Lower rates at this point may have a short-term beneficial effect on the market, but by the time of next year’s election, it is just as likely to look like a huge mistake as it is a good idea.
Donald Trump has had no problem to this point taking credit for the strong economy. Why not just continue in the same vein and leave open the opportunity to blame the Fed if things turn south?
Attacking now, especially by saying that the Fed doesn’t know what they are doing and that it is a “bigger problem than U.S. competitors” can therefore only be about belittling the target. The stated aim, be it lunch money or a rate cut, is irrelevant. In fact, the Fed has already given up its lunch money, indicating an intention to cut rates at this month’s meeting that would now be hard to take back. Piling on now is about consolidating the power that indicates.
So, what does all this mean for investors?
Jerome Powell is no cowering kid in a playground, but he is all too aware that if he fights back and just says no, it could well cost him his job. In that context a small cut in short-term rates that the market has already priced in doesn’t look like too big an ask, but he may use this week’s testimony to hint at making a stand.
In that scenario, either he wins and further cuts are off the table, pushing the market lower, or he gets fired, and we just saw in Turkey how global markets react to removing central bank independence.
When Powell testifies to Congress this week, anything short of a promise to cut rates multiple times this year will put pressure on stocks. Given the implications for the long-term independence of the Fed though, even that would result in only a short-term bump. So, whether your preferred hedge is through futures, a leveraged ETF or the VIX, preparing for the worst while hoping for the best by guarding against a drop this week would make sense.