The Fed’s Trump trap

The Federal Reserve may be damned if it raises interest rates and damned if it doesn’t.

Recently appointed Fed Chair Jerome Powell had only just started his new job last Monday when the stock market nosedived 1,100 points. Then it plunged another 1,000 points on Thursday, before ticking up Friday. All told, the Dow Jones Industrial Average and the S&P 500 both ended last week down over 5 percent. Now everyone is on pins and needles, wondering if the rout will continue.

Typically, stocks don’t play a big role in the Fed’s most important decision — whether to adjust interest rates up and down — since market swings can be pretty disconnected from economic fundamentals. Nonetheless, this plunge puts both Powell and the entire Fed in a very tricky position.

Despite its questionable relevance to the real economy, the stock market is such a popular indicator of economic wellbeing that Fed chairs and presidents alike can hardly ignore it. Yet stocks’ fickleness means it’s dangerous for politicians to take direct credit for their booms: If the market suddenly busts, why isn’t that your fault too?

President Trump, of course, has shown no such caution. Over the last year, he’s repeatedly credited himself for the booming market. “The reason our stock market is so successful is because of me,” he said in November. So last week’s crash-and-burn was a nasty surprise:

In the “old days,” when good news was reported, the Stock Market would go up. Today, when good news is reported, the Stock Market goes down. Big mistake, and we have so much good (great) news about the economy!

— Donald J. Trump (@realDonaldTrump) February 7, 2018

Meanwhile, the White House tried to retcon Trump’s own behavior, stating, “the president’s focus is on our long-term economic fundamentals.”

Here’s how the Fed gets involved: The good news Trump was referring to was a 2.9 percent jump in wages from January 2016 to January 2017. In the Fed’s standard models, rising wages are a big driver of rising inflation. If it suddenly expects inflation to rise more than it’s been projecting, the Fed may hike interest rates more aggressively to contain it. That would dampen future stock returns, changing investors’ whole calculus around holding or selling.

Subtle changes in the Fed’s wording around monetary policy already had everyone nervous. So when the wage spike report dropped, the markets panicked. It really was a weird, good-news-is-bad-news scenario.

But was the freakout justified? “The current selloff is entirely technical in nature, that fundamentals did not change,” said Marko Kolanovic, an analyst at JPMorgan. “We believe that it’s an opportunity for human investors with some tolerance for market volatility to step in.” Translation: Everyone needs to calm down.

But Kolanovic took his analysis a step further by invoking Trump himself: “We also want to add that the new Fed chair, vetted by the current administration that uses the stock market as a score …read more

Source:: The Week – Business


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