Tag Archives: Donald Trump

What is Bill Dudley Thinking?

On August 27, 2019, Bill Dudley, former Chief Economist for Goldman Sachs and President of the Federal Reserve Bank of New York from 2009-2018, published a stunning editorial in Bloomberg (LINK). After reading the article numerous times, there are a few noteworthy observations worth discussing.

Dudley’s Myopic View

Before we dissect Bill Dudley’s opinions and try to understand his motivations, consider the article’s subtitle- “The central bank should refuse to play along with an economic disaster in the making.”

There is little doubt that Trump’s hard stance on trade and the seemingly impetuous use of tariffs and harsh Twitter commentary presents new challenges for economic growth. Global trade has slowed and manufacturers are retrenching to limit their risks.

Whether the trade war is or will be an “economic disaster” as Dudley says, is up for debate. What is remarkable about this comment is the lack of understanding of the economic instability prior to the trade war and how it got to that point.   

As we have discussed on numerous occasions, the Fed has used excessive monetary policy over the last decade to promote economic growth. Dudley and the Fed fail to recognize that their actions have led to rampant speculation in the financial markets, encouraged significant uses of debt for nonproductive purposes, and have fueled the wealth and income divergences. More concerning, their actions have reduced the natural economic growth rate of the country for years and possibly decades to come. Dudley and colleagues arranged the tinder for what will inevitably be an economic disaster. Trump may or may not be the spark.

Dudley sets up his article with a leading question-“This manufactured disaster-in-the-making presents the Federal Reserve with a dilemma: Should it mitigate the damage by providing offsetting stimulus, or refuse to play along?”

He answers, in part, by saying that, based on the Fed’s obligations and “conventional wisdom”, the Fed should respond to economic weakness due to the trade war by “adjusting monetary policy accordingly.” Historically, the Fed has changed policy to counter outside, non-economic factors.

Dudley, however, takes a different tack and asks if easier Fed policy would encourage “the President to escalate the trade war further.” This is where the editorial gets political. He goes on to state his case for the Fed taking a hard line and not adjust monetary policy if the trade war negatively affects economic activity. Dudley believes that by doing nothing, the Fed would:

  • Discourage further trade war escalation
  • Reinforce the Fed’s independence
  • Preserve much needed “ammunition”, as there is little room to cut rates

In the next paragraph, he stresses Trump’s attacks on Chairman Powell and provides more reasoning for the Fed to leave policy alone. Dudley believes the Fed, by not adjusting monetary policy to offset the effects of the trade war in progress, would send a clear signal to the President that he bears the risks of a recession and losing an election. The Fed, thereby, would not be complicit.  

Before going on, we think it’s appropriate to re-emphasize that the next recession will be amplified due to Fed actions over the last ten years. Bernanke should never have extended extraordinary measures beyond the first round of quantitative easing, and Janet Yellen had ample opportunities to raise interest rates and reduce the Fed’s balance sheet during her tenure. Trying to place all of the blame on the current President, or anyone else for that matter, may work in the media and even the populace but it does not line up with the facts.

Dudley’s Summary

Dudley concludes with a stunning and politically motivated statement- “There’s even an argument that the election itself falls within the Fed’s purview. After all, Trump’s reelection arguably presents a threat to the U.S. and global economy, to the Fed’s independence and its ability to achieve its employment and inflation objectives. If the goal of monetary policy is to achieve the best long-term economic outcome, then Fed officials should consider how their decisions will affect the political outcome in 2020.”   

Dudley is essentially imploring Powell to base monetary policy on the coming election. If Fed independence is what Dudley cherishes, he certainly did not do the Fed any favors. This implicates elites like Dudley, one of the “Davos Men,” who think they know better than the collective decisions of people engaged in free-market exchanges. It also makes him guilty of an effort to manipulate an election.

Summary

Here is an important question. Is this editorial solely Dudley’s thoughts, or was Jerome Powell and the Fed involved in any way?  The Fed has already come out against the article, but in Washington, nothing is ever that clear cut.

If the editorial was in some way subsidized or suggested by Powell, the implications of the Fed going after the President will call into question their independence in the future. No matter how deeply improper that is, it certainly leaves open the question of whether or not people are justified in those efforts. In the same way that no Fed official should ever be viewed as complicit, no President should impose his will from the bully pulpit of the Presidency to influence monetary policy.

From an investment perspective, this is not good. The markets have benefited from a Fed that has promoted asset price inflation and sought to convince us that the economic cycle is dead. Despite sky-high valuations, investors tend to believe that these valuations are fair and that the Fed will always be there as a reliable safety net.

We do not know how this saga will end, but we do know that if confidence in the Fed is compromised, investors will likely vote with their feet.

Caroline’s Summary

We leave you with some thoughts on the subject from Caroline Baum of MarketWatch:

“It is hard to fathom what Dudley was thinking in advocating such an off-the-wall idea of factoring political outcomes into policy decisions. The Fed has a dual mandate from Congress to promote maximum employment and price stability. There is nothing in that mandate, or in the Federal Reserve Act, about influencing election outcomes. Nothing in there either about being part of “the Resistance” to this president.

That would be a dangerous expansion of Federal Reserve’s operating framework.”

The Prospects of a Weaker Dollar Policy- RIA Pro

This version, for RIA Pro subscribers, contains a correlation table at the end of the article to help better quantify short and longer term relationships between the dollar and other financial assets.

“Let me be clear, what I said was, it’s not the beginning of a long series of rate cuts.”- Fed Chairman Jerome Powell -7/31/2019

“What the Market wanted to hear from Jay Powell and the Federal Reserve was that this was the beginning of a lengthy and aggressive rate-cutting cycle which would keep pace with China, The European Union and other countries around the world….” – President Donald Trump – Twitter 7/31/2019

With the July 31, 2019 Fed meeting in the books, President Trump is up in arms that the Fed is not on a “lengthy and aggressive rate-cutting” path. Given his disappointment, we need to ask what else the President can do to stimulate economic growth and keep stock investors happy. History conveys that is the winning combination to win a reelection bid.

Traditionally, a President’s most effective tool to spur economic activity and boost stock prices is fiscal policy. With a hotly contested election in a little more than a year and the House firmly in Democratic control, the odds of meaningful fiscal stimulus before the election is low.

Without fiscal support, a weak dollar policy might be where Donald Trump goes next. A weaker dollar could stimulate export growth as goods and services produced in the U.S. become cheaper abroad. Further, a weaker dollar makes imports more expensive, which would increase prices and in turn push nominal GDP higher, giving the appearance, albeit false, of stronger economic growth.

In this article, we explore a few different ways that President Trump may try to weaken the dollar. 

Weaker Dollar Policy

The impetus to write this article came from the following Wall Street Journal article: Trump Rejected Proposal to Weaken Dollar through Market Intervention. In particular, the following two paragraphs contradict one another and lead us to believe that a weaker dollar policy is a possibility. 

On Friday, Mr. Kudlow said Mr. Trump “ruled out any currency intervention” after meeting with his economic team earlier this week. The comments led the dollar to rise slightly against other currencies, the WSJ Dollar index showed.

But on Friday afternoon, Mr. Trump held out the possibility that he could take action in the future by saying he hadn’t ruled anything out. “I could do that in two seconds if I wanted to,” he said when asked about a proposal to intervene. “I didn’t say I’m not going to do something.”

Based on the article, Trump’s advisers are against manipulating the dollar lower as they don’t believe they can succeed. That said, on numerous occasions, Trump has shared his anger over other countries that are “using exchange rates to seek short-term advantages.”

As shown below, two measures of the U.S. dollar highlight the substance of frustrations being expressed by Trump. The DXY dollar index has appreciated considerably from the early 2018 lows but is still well below levels at the beginning of the century. This index is inordinately influenced by the euro and therefore not 100% representative of the true effect that the dollar has on trade. The Trade-weighted dollar which is weighted by the amount of trade that actually takes place between the U.S. and other countries. That index has also bounced from early 2018 lows and, unlike DXY, has reached the highs of 2002.

Data Courtesy Bloomberg

Trump’s Dollar War Chest

The following section provides details on how the President can weaken the dollar and how effective such actions might be.

Currency Market Intervention

Intervening in the currency markets by actively selling US dollars would likely push the dollar lower. The problem, as Trump’s advisers note, is that any weakness achieved via direct intervention is likely to be short-lived.

The US economy is stronger than most other developed countries and has higher interest rates. Both are reasons that foreign investors are flocking to the dollar and adding to its recent appreciation. Assuming economic activity does not decline rapidly and interest rates do not plummet, a weaker dollar would further incentivize foreign flows into the dollar and partially or fully offset any intervention.

More importantly, there is a global dollar shortage to consider. It has been estimated by the Bank of International Settlements (BIS) that there is $12.8 trillion in dollar-denominated liabilities owed by foreign entities. A stronger dollar causes interest and principal payments on this debt to become more onerous for the borrowers. Dollar weakness would be an opportunity for some of these borrowers to buy dollars, pay down their debts and reduce dollar risk. Again, such buying would offset the Treasury’s actions to depress the dollar.  

Instead of direct intervention in the currency markets, Trump and Treasury Secretary Steve Mnuchin can use speeches and tweets to jawbone the dollar lower. Like direct intervention, we also think that indirect intervention via words would have a limited effect at best.

The economic and interest rate fundamentals driving the stronger dollar may be too much for direct or indirect intervention to overcome.

From a legal perspective intervening in the currency markets is allowed and does not require approval from Congress. Per the Wall Street Journal article, “The 1934 Gold Reserve Act gives the White House broad powers to intervene, and the Treasury maintains a fund, currently of around $95 billion, to carry out such operations.” The author states that the Treasury has not conducted any interventions since 2000. That is not entirely true as they conducted a massive amount of currency swaps with other nations during and after the financial crisis. By keeping these large market-moving trades off the currency markets, they very effectively manipulated the dollar and other currencies.

Hounding the Fed

The President aggressively chastised Fed Chairman Powell for not cutting interest rates or ending QT as quickly as he prefers. Lowering interest rates to levels that are closer to those of other large nations would potentially weaken the dollar. The only problem is that the Fed does not appear willing to move at the President’s pace as they deem such action is not warranted. We believe the Fed is very aware that taking unjustifiable actions at the behest of the President would damage the perception of their independence and, therefore, their integrity.

To solve this problem, Trump could take the controversial and unprecedented step of firing or demoting Fed Chairman Powell.  In Powell’s place he could put someone willing to lower rates aggressively and possibly reintroduce QE. These steps might push financial asset prices higher, weaken the dollar, and provide the economic pickup Trump seeks but it is also fraught with risks. We have written two articles on the topic of the President firing the Fed Chairman as follows: Chairman Powell You’re Fired and Market Implications for Removing Fed Chair Powell.

It is not clear whether the President can get away with firing or even demoting Chairman Powell. We guess that he understands this which may explain why he has not done it already. If he cannot change Fed leadership, he can continue to pressure the Fed with Tweets, speeches, and direct meetings. We do not think this strategy can be effective unless the Fed has ample reason to cut rates. Thus far, the Fed’s mandates of “maximum employment, stable prices, and moderate long-term interest rates” do not provide the Fed such justification.

Getting Help Abroad

One of the core topics in the U.S. – China trade talks has been the Chinese Yuan. In particular, Trump is negotiating to stop the Chinese from using their currency to promote their economic self-interests at our expense. As of writing this, the U.S. Treasury deemed China a currency manipulator. Per the Treasury: “As a result of this determination (currency manipulator), Secretary Mnuchin will engage with the International Monetary Fund to eliminate the unfair competitive advantage created by China’s latest actions.” Said differently, the U.S. and other nations can now manipulate their currency versus the Chinese Yuan.

It is plausible that Trump might pressure other countries, including our allies in Europe and Japan as well as Mexico and Canada, to strengthen their respective currencies against the dollar. Trump can threaten nations with trade restrictions and tariffs if they do not comply. If tariffs are enacted, however, all bets are off due to the economic inefficiencies of tariffs or trade restrictions. To the President’s dismay, such action weaken the economy and scare investors as we are seeing with China. 

Threats of trade actions, trade-related actions, or trade agreements might work to weaken the dollar, but such tactics would require time and pinpoint diplomacy. Of all the options, this one requires longer-term patience in awaiting their effect and may not satisfy the President’s desire for short-term results.

Summary

Before summarizing we leave you with one important thought and certainly a topic for future writings. Globally coordinated monetary policy is morphing into globally competitive monetary policy. This may be the most significant Macro development since the Plaza Accord in 1985 when the Reagan administration, along with other developed nations (West Germany, France, Japan, the UK), coordinated to weaken the U.S. dollar.

With the Presidential election in about 15 months, we have no doubt that President Trump will do everything in his power to keep financial markets and the economy humming along. The problem facing the President is a Democrat-controlled House, a Fed that is dragging their feet in terms of rate cuts, weakening global growth, and a stronger U.S. dollar.

We believe the odds that the President tries to weaken the dollar will rise quickly if signs of further economic weakness emerge. Given the situation, investors need to understand what the President can and cannot do to spike economic growth and further how it might affect the prices of financial assets.

On the equity front, a weaker dollar bodes well for companies that are more global in nature. Most of the companies that have driven the equity indices higher are indeed multi-national. Conversely, it harms domestic companies that rely on imported goods and commodities to manufacture their products. The price of commodities and precious metals are likely to rise with a weaker dollar. A weaker dollar and any price pressures that result would likely push bond yields higher.

The relationships between the dollar and various asset classes are important to monitoring how intentional changes in the value of the dollar may impact all varieties of asset classes. The addendum below quantifies short and longer-term correlations.

Addendum – Short & Long-term Asset Correlations

The following tables present short term daily correlations and longer-term weekly correlations between the dollar and several asset classes and sub-asset classes. The correlation data for each asset quantifies how much the price of the asset is affected by the price of the dollar. A positive correlation means the dollar and the asset tend to move in similar directions. Conversely, a negative relationship means they move in opposite directions. We highlighted all relationships that are +/- .30. The closer the number is to 1 or -1, the stronger the relationship. CLICK TO ENLARGE

The Prospects of a Weaker Dollar Policy

“Let me be clear, what I said was, it’s not the beginning of a long series of rate cuts.”- Fed Chairman Jerome Powell -7/31/2019

“What the Market wanted to hear from Jay Powell and the Federal Reserve was that this was the beginning of a lengthy and aggressive rate-cutting cycle which would keep pace with China, The European Union and other countries around the world….” – President Donald Trump – Twitter 7/31/2019

With the July 31, 2019, Fed meeting in the books, President Trump is up in arms that the Fed is not on a “lengthy and aggressive rate-cutting” path. Given his disappointment, we need to ask what else the President can do to stimulate economic growth and keep stock investors happy. History conveys that is the winning combination to win a reelection bid.

Traditionally, a President’s most effective tool to spur economic activity and boost stock prices is fiscal policy. With a hotly contested election in a little more than a year and the House firmly in Democratic control, the odds of meaningful fiscal stimulus before the election is low.

Without fiscal support, a weak dollar policy might be where Donald Trump goes next. A weaker dollar could stimulate export growth as goods and services produced in the U.S. become cheaper abroad. Further, a weaker dollar makes imports more expensive, which would increase prices and in turn push nominal GDP higher, giving the appearance, albeit false, of stronger economic growth.

In this article, we explore a few different ways that President Trump may try to weaken the dollar. 

Weaker Dollar Policy

The impetus to write this article came from the following Wall Street Journal article: Trump Rejected Proposal to Weaken Dollar through Market Intervention. In particular, the following two paragraphs contradict one another and lead us to believe that a weaker dollar policy is a possibility. 

On Friday, Mr. Kudlow said Mr. Trump “ruled out any currency intervention” after meeting with his economic team earlier this week. The comments led the dollar to rise slightly against other currencies, the WSJ Dollar index showed.

But on Friday afternoon, Mr. Trump held out the possibility that he could take action in the future by saying he hadn’t ruled anything out. “I could do that in two seconds if I wanted to,” he said when asked about a proposal to intervene. “I didn’t say I’m not going to do something.”

Based on the article, Trump’s advisers are against manipulating the dollar lower as they don’t believe they can succeed. That said, on numerous occasions, Trump has shared his anger over other countries that are “using exchange rates to seek short-term advantages.”

As shown below, two measures of the U.S. dollar highlight the substance of frustrations being expressed by Trump. The DXY dollar index has appreciated considerably from the early 2018 lows but is still well below levels at the beginning of the century. This index is inordinately influenced by the euro and therefore not 100% representative of the true effect that the dollar has on trade. The Trade-weighted dollar which is weighted by the amount of trade that actually takes place between the U.S. and other countries. That index has also bounced from early 2018 lows and, unlike DXY, has reached the highs of 2002.

Data Courtesy Bloomberg

Trump’s Dollar War Chest

The following section provides details on how the President can weaken the dollar and how effective such actions might be.

Currency Market Intervention

Intervening in the currency markets by actively selling US dollars would likely push the dollar lower. The problem, as Trump’s advisers note, is that any weakness achieved via direct intervention is likely to be short-lived.

The US economy is stronger than most other developed countries and has higher interest rates. Both are reasons that foreign investors are flocking to the dollar and adding to its recent appreciation. Assuming economic activity does not decline rapidly and interest rates do not plummet, a weaker dollar would further incentivize foreign flows into the dollar and partially or fully offset any intervention.

More importantly, there is a global dollar shortage to consider. It has been estimated by the Bank of International Settlements (BIS) that there is $12.8 trillion in dollar-denominated liabilities owed by foreign entities. A stronger dollar causes interest and principal payments on this debt to become more onerous for the borrowers. Dollar weakness would be an opportunity for some of these borrowers to buy dollars, pay down their debts and reduce dollar risk. Again, such buying would offset the Treasury’s actions to depress the dollar.  

Instead of direct intervention in the currency markets, Trump and Treasury Secretary Steve Mnuchin can use speeches and tweets to jawbone the dollar lower. Like direct intervention, we also think that indirect intervention via words would have a limited effect at best.

The economic and interest rate fundamentals driving the stronger dollar may be too much for direct or indirect intervention to overcome.

From a legal perspective intervening in the currency markets is allowed and does not require approval from Congress. Per the Wall Street Journal article, “The 1934 Gold Reserve Act gives the White House broad powers to intervene, and the Treasury maintains a fund, currently of around $95 billion, to carry out such operations.” The author states that the Treasury has not conducted any interventions since 2000. That is not entirely true as they conducted a massive amount of currency swaps with other nations during and after the financial crisis. By keeping these large market-moving trades off the currency markets, they very effectively manipulated the dollar and other currencies.

Hounding the Fed

The President aggressively chastised Fed Chairman Powell for not cutting interest rates or ending QT as quickly as he prefers. Lowering interest rates to levels that are closer to those of other large nations would potentially weaken the dollar. The only problem is that the Fed does not appear willing to move at the President’s pace as they deem such action is not warranted. We believe the Fed is very aware that taking unjustifiable actions at the behest of the President would damage the perception of their independence and, therefore, their integrity.

To solve this problem, Trump could take the controversial and unprecedented step of firing or demoting Fed Chairman Powell.  In Powell’s place he could put someone willing to lower rates aggressively and possibly reintroduce QE. These steps might push financial asset prices higher, weaken the dollar, and provide the economic pickup Trump seeks but it is also fraught with risks. We have written two articles on the topic of the President firing the Fed Chairman as follows: Chairman Powell You’re Fired and Market Implications for Removing Fed Chair Powell.

It is not clear whether the President can get away with firing or even demoting Chairman Powell. We guess that he understands this which may explain why he has not done it already. If he cannot change Fed leadership, he can continue to pressure the Fed with Tweets, speeches, and direct meetings. We do not think this strategy can be effective unless the Fed has ample reason to cut rates. Thus far, the Fed’s mandates of “maximum employment, stable prices, and moderate long-term interest rates” do not provide the Fed such justification.

Getting Help Abroad

One of the core topics in the U.S. – China trade talks has been the Chinese Yuan. In particular, Trump is negotiating to stop the Chinese from using their currency to promote their economic self-interests at our expense. As of writing this, the U.S. Treasury deemed China a currency manipulator. Per the Treasury: “As a result of this determination (currency manipulator), Secretary Mnuchin will engage with the International Monetary Fund to eliminate the unfair competitive advantage created by China’s latest actions.” Said differently, the U.S. and other nations can now manipulate their currency versus the Chinese Yuan.

It is plausible that Trump might pressure other countries, including our allies in Europe and Japan as well as Mexico and Canada, to strengthen their respective currencies against the dollar. Trump can threaten nations with trade restrictions and tariffs if they do not comply. If tariffs are enacted, however, all bets are off due to the economic inefficiencies of tariffs or trade restrictions. To the President’s dismay, such action weaken the economy and scare investors as we are seeing with China. 

Threats of trade actions, trade-related actions, or trade agreements might work to weaken the dollar, but such tactics would require time and pinpoint diplomacy. Of all the options, this one requires longer-term patience in awaiting their effect and may not satisfy the President’s desire for short-term results.

Summary

Before summarizing we leave you with one important thought and certainly a topic for future writings. Globally coordinated monetary policy is morphing into globally competitive monetary policy. This may be the most significant Macro development since the Plaza Accord in 1985 when the Reagan administration, along with other developed nations (West Germany, France, Japan, the UK), coordinated to weaken the U.S. dollar.

With the Presidential election in about 15 months, we have no doubt that President Trump will do everything in his power to keep financial markets and the economy humming along. The problem facing the President is a Democrat-controlled House, a Fed that is dragging their feet in terms of rate cuts, weakening global growth, and a stronger U.S. dollar.

We believe the odds that the President tries to weaken the dollar will rise quickly if signs of further economic weakness emerge. Given the situation, investors need to understand what the President can and cannot do to spike economic growth and further how it might affect the prices of financial assets.

On the equity front, a weaker dollar bodes well for companies that are more global in nature. Most of the companies that have driven the equity indices higher are indeed multi-national. Conversely, it harms domestic companies that rely on imported goods and commodities to manufacture their products. The price of commodities and precious metals are likely to rise with a weaker dollar. A weaker dollar and any price pressures that result would likely push bond yields higher.

The statistical relationships between the dollar and other asset classes are important to quantify if in fact the dollar may become an economic tool for the President. A full spectrum of those relationships over various timeframes may be found in an addendum to this article for RIA Pro subscribers. Give us a try. All new subscribers receive a 30 day free trial to explore what we have to offer and view the addendum.   

Steepening Yield Curve Could Yield Generational Opportunities : Michael Lebowitz on Real Vision

On July 1st, Michael Lebowitz was interviewed by Real Vision TV. In the interview he discussed our thoughts on the yield curve, corporate bonds, recession odds, the Federal Reserve, and much more. In particular, Michael pitched our recent portfolio transactions NLY and AGNC, which were both discussed in the following RIA PRO article: Profiting From a Steepening Yield Curve.

Real Vision was kind enough to allow us to share their exclusive video with RIA Pro clients. We hope you enjoy it.

To watch the Video please click HERE

Are Fireworks Coming July 31st?

As a portfolio manager and fiduciary, it is vital that we constantly assess the risks to our market and economic forecasts. To better quantify risk we must frequently go a step further and understand where the markets may be neglecting to appreciate risk. While tricky, those that properly detect when the market is offside tend to either protect themselves and/or profit handsomely. It is with contrarian glasses on that we look beyond July 4th and towards July 31st for fireworks.

Through June the stock and bond markets priced in, with near certainty, a 50 basis point rate cut at the July 31, 2019, Federal Reserve FOMC meeting. In doing so, volatility in many markets could surge if the Fed does not follow the market’s lead.

Given this concern, we ask what might cause the Fed to disappoint the markets. We approach the answer from two angles, economic and political.

Economic

On the economic front, there are a growing number of indicators that point to slowing domestic economic growth. The following graph from Arbor shows seven important leading indicators (surveys and outlooks).

While the graph is concerning, hard economic data which tends to lag the survey data graphed above has yet to weaken to the same degree. If the weakening in the indicators graphed above prove to be a false signal or transitory, the Fed might cut rates less than expected or even delay taking policy actions.

A second reason the Fed might delay or not take action would be an increase in inflation expectations. The Fed has been outspoken about the need to bolster inflation expectations which have recently drifted lower. Given that unemployment is at 50 years lows and inflation close to their target, inflation expectations seems to be the rationale the Fed is using to justify action. If inflation expectations were to increase the Fed may not be able to defend reducing rates. The following events could temporarily increase inflation expectations:

  • Weaker dollar due to perceived easy monetary policy.
  • Iran tensions could push oil prices higher.
  • Excessive weather conditions in the Midwest are affecting consumer prices for certain commodities.
  • Tariffs are likely to increase prices paid by businesses and consumers.
  • Fed independence compromised (as discussed in the following paragraph).

Political

Beyond economics, politics is playing a role in the Fed’s thought process. The Fed was set up as an independent organization to insulate monetary policy from the often self-serving demands of the executive and legislative branches. Despite the Fed’s independence, many Presidents have bullied the Fed to take policy actions. Such tactics always occurred behind closed doors with the media and public having little idea that they were occurring.

Currently, President Trump is taking his criticism to the public airways and has gone as far as threatening to demote or fire Chairman Powell. A Fed Chairman has never been fired or demoted, leading many to question whether Trump has the legal authority to do so. The Federal Reserve Act states that the Chairman shall serve his stated term “unless sooner removed for cause by the President.” That sentence opens the door to much uncertainty under this President. The language is even less vague about demotion, which, in our opinion, is more likely.

If the Fed wants to assert its independence from the executive branch, they may be inclined to cut by 25 basis points or possibly not cut at all.  Anything short of a 50 basis point rate cut would inevitably irritate the President and increase the risk that Trump fires or demotes Powell. If such an unprecedented action were to transpire the markets would likely react violently. For more on how certain asset classes might perform in this scenario, please read our article Market Implications for Removing Fed Chair Powell.

Beyond the initial market responses to the news, a greater problem could arise. The peril of openly piercing the veil of independence at the Fed could impair many of the communication tools the Fed uses to influence policy and markets. In turn, the Fed will be limited in their ability to coax or pacify markets when needed.

While this spat may be brushed off as Beltway politics aired for the public in the Twittersphere and media, the consequences are large, and as such we must pay attention to this political soap opera.

Summary

We believe a 50 basis point cut is likely on July 31st and afterward the markets will renew their focus on the next few months and what that may have in store. However, unlike the vast majority, we believe that there are factors that may cause the Fed to sit on their hands. If the Fed disappoints the market, especially if not accompanied by warnings, the July fireworks this year may be coming 27 days late.

Market Implications For Removing Fed Chair Powell

  • John Kelly – White House Chief of Staff
  • James Mattis – Secretary of Defense
  • Jeff Sessions – Attorney General
  • Rex Tillerson – Secretary of State
  • Gary Cohn – Chief Economic Advisor
  • Steve Bannon – White House Chief Strategist
  • Anthony Scaramucci – White House Communications Director
  • Reince Priebus – White House Chief of Staff
  • Sean Spicer – White House Press Secretary
  • James Comey – FBI Director

Every week is shark week in the Trump White House,” wrote The Hill contributing author Brad Bannon in August of 2018.  A recent Brookings Institution study shows that the turnover in the Trump administration is significantly higher than during any of the previous five presidential administrations. The concern is that for a president without government experience, a rotating cast of top administration officials and advisors presents a unique challenge for the effective advancement of U.S. policies and global leadership. Bannon (no relation to former White House Chief Strategist Steve) adds, “Inexperience breeds incompetence.”

Although the sitting president has broken just about every rule of traditional politics, it is irresponsible and speculative to assume either ineffectiveness or failure by this one argument. One area of politics that falls within our realm of expertise is a “rule” that Donald Trump has not yet broken; firing the Chairman of the Federal Reserve.

Following the December Federal Open Market Committee (FOMC) meeting in which the Fed raised rates and the stock market fell appreciably, Bloomberg News reported that President Trump was again considering relieving the Fed Chairman of his responsibilities. This has been a continuing theme for Trump as his dissatisfaction with the Fed intensifies.

Not that Trump appears concerned about it, but firing a Fed Chairman is unprecedented in the 106-year history of the central bank. Having tethered all perception of success to the movements of the stock market, it is quite apparent why the president is unhappy with Jerome Powell’s leadership. Trump’s posture raises questions about whether he is more worried about his barometer of success (stock prices) or the long-term well-being of the economy. Acquiescing to either Trump or a genuine concern for the economic outlook, Chairman Powell relented in his stance on rate hikes and continuing balance sheet reduction.

Clamoring for Favor

Notwithstanding the abrupt reversal of policy stance at the Fed, President Trump continues to snipe at Powell and express dissatisfaction with what he considers to have been policy mistakes. Before backing out of consideration, Steven Moore’s nomination to the Fed board fits neatly with the points made above reflecting the President’s irritation with the Powell Fed. Moore was harshly critical of Powell and the Fed’s rate hikes despite a multitude of inconsistent remarks. Shortly after his nomination, Moore and the President’s Director at the National Economic Council, Larry Kudlow, stated that the Fed should immediately cut interest rates by 50 basis point (1/2 of 1%). Those comments came despite rhetoric from various fronts in the administration that the economy “has never been stronger.”

Now the Kudlow and Moore tactics are coming from within the Fed. St. Louis Fed President James Bullard dissented at the June 19th Federal Open Market Committee meeting in favor a rate cut. Then non-voting member and Minneapolis Fed President Neel Kashkari publicly stated that he was an advocate for a 50-basis point rate cut at the same meeting.

All this with unemployment at 3.6% and GDP tracking better than the 10-year average of 2.1%. Given Trump’s stated grievance with Powell, Bullard and Kashkari could easily be viewed as trying to curry favor with the administration. Even if that is not the case, to appear to be so politically inclined is very troubling for an institution and board members that must optically maintain an independent posture. It is unlikely that anyone has influence over Trump in his decision to replace or demote Powell. He will arrive at his conclusion and take action or not. If the first two years of his administration tells us anything, it is that public complaints about his appointed cabinet members precede their ultimate departure. Setting aside his legal authority to remove Powell, which would likely not stand in his way, the implications are what matter and they are serious.

For more on our thoughts on the ability of Trump to fire the Fed Chairman, please read our article Chairman Powell You’re Fired.

Prepare For This Tweet

Given Trump’s track record and his displeasure with Powell, we should prepare in advance for what could come as a surprise Tweet with little warning.

Ignoring legalities, if Trump were to demote or fire Powell, it is safe to assume he has someone in mind as a replacement. That person would certainly be more dovish and less prudent than Powell.

Under circumstances of a voluntary departure, a replacement with a more dovish disposition might be bullish for the stock market. However, the global economy is a complex system and there are many other factors to consider.

The first and largest problem is such a move would immediately erode the perception of Fed independence. Direct action taken to alter that independence would cast doubts on Fed credibility. Other sitting members of the Federal Reserve, appointed board members, and regional bank presidents, would likely take steps to defend the Fed’s independence and credibility which could create a functional disruption in the decision-making apparatus within the FOMC. Further, there might also be an active move by Congress to challenge the President’s decision to remove Powell. Although the language granting Trump the latitude to fire Powell is obtuse (he can be removed for “cause”), it is unclear that Presidential unhappiness affords him supportable justification. That would be an argument for the courts. Financial markets are not going to patiently await that decision.

With that in mind, what follows is an enumeration of possible implications for various key asset classes.

FX Markets

The most serious of market implications begin with the U.S. dollar (USD), the world’s reserve currency through which over 60% of all global trade transactions are invoiced.  The firing of Powell and the likely appointment of a Trump-friendly Chairman would drop the value of the USD on the expectations of a dovish reversal of monetary policy. The question of Fed independence, along with the revival of an easy money policy, would likely cause the dollar to fall dramatically relative to other key currencies. An abrupt move in the dollar would be highly disruptive on a global scale, as other countries would take action to stem the relative strength of their currencies versus the dollar and prevent weaker economic growth effects. The term “currency war” has been overused in the media, but in this case, it is the proper term for what would likely transpire.

Additionally, the weaker dollar and new policy outlook would heighten concerns about inflation. With the economy at or near full employment and most regions of the country already exhibiting signs of wage pressures, inflation expectations could spike higher.

Fixed Income

The bond market would be directly impacted by Fed turbulence. A new policy outlook and inflation concerns would probably cause the U.S. Treasury yield curve to steepen with 2-year Treasuries rallying on FOMC policy change expectations and 10-year and 30-year Treasury bond yields rising in response to inflation concerns. It is impossible to guess the magnitude of such a move, but it would probably be sudden and dramatic.

Indecision and volatility in the Treasury markets are likely to be accompanied by widening spreads in other fixed income asset classes.

Commodities

In the commodities complex, gold and silver should be expected to rally sharply.  While not as definitive, other commodities would probably also do well in response to easier Fed policy. A lack of confidence in the Fed and the President’s actions could easily result in economic weakness, which would lessen demand for many industrial commodities and offset the benefits of Fed policy changes.

Stock Market

The stock market response is best broken down into two phases. The initial reaction might be an extreme move higher, possibly a move of 8-10% or more in just a few days or possibly hours. However, the ensuing turmoil from around the globe and the potential for dysfunction within the Fed and Congress could cause doubt to quickly seep into the equity markets. Two things we know about equity markets is that they do not like changes in inflation expectations and they do not like uncertainty.

Economy

Another aspect regarding such an unprecedented action would be the economic effects of the firing of Jerome Powell. Economic conditions are a reflection of millions of households and businesses that make saving, investing, and consumption decisions on a day-to-day basis. Those decisions are dependent on having some certitude about the future.

If the disruptions were to play out as described, consumers and businesses would have reduced visibility into the future path for the economy. Questions about the global response, inflation, interest rates, stock, and commodity prices would dominate the landscape and hamstring decision-making. As a result, the volatility of everything would rise and probably in ways not observed since the financial crisis. Ultimately, we would expect economic growth to falter in that environment and for a recession to ensue.

Summary

Although economic growth has been sound and stocks are once again making record highs, the market and economic disruptions we have recently seen have been a long time coming. Market valuations across most asset classes have been engineered by excessive and imprudent monetary policy. The recent growth impulse is artificially high due to unprecedented expansion of government debt in a time of sound economic growth and low unemployment. In concert, excessive fiscal and monetary policy leave the markets and the economy vulnerable.

The evidence this year has been clear. Notwithstanding the Federal Reserve’s role in constructing this false reality, President Trump has not served the national interest well by his public criticism of the Fed. If Trump were to remove Powell as Fed chair, the prior sentence would be an understatement of epic proportions.

Chairman Powell – You’re Fired (Update)

Since President Trump first discussed firing Jerome Powell, out of a sense of frustration that his Fed Chair pick was not dovish enough, he has regularly expressed his displeasure at Powell’s lack of willingness to do whatever it takes to keep the economy booming beyond its potential. Strong economic growth serves Trump well as it boosts the odds of winning a second term.

This thought of firing the Fed Chair took an interesting turn yesterday when Mario Draghi, Jerome Powell’s counter-part in the ECB, commented that he was open to lowering interest rates and expanding quantitative easing measures if economic growth in the E.U. didn’t start to pick up soon.

This led to the following Trump tweet:

The bottom line is that the ECB will push Trump harder to lean on the Fed to be more aggressive with lower rates and QE. Trump’s urgency for Fed action also increases the odds that Powell could be replaced or demoted, as such a discussion was rumored to have been discussed. Look for fireworks on Trumps Twitter page today if the Fed does not take a dovish tact. We remind you:

“[Powell]’s my pick — and I disagree with him entirely,” Trump said last week in an interview with ABC News.

“Frankly, if we had a different person in the Federal Reserve that wouldn’t have raised interest rates so much we would have been at least a point and a half higher.”

The following article was published last October and is even more relevant today. If Powell becomes an impediment to aggressive Federal Reserve policy and therefore hurts Trump’s chances of winning in 2020, we might just see Chairman Powell get fired or demoted. Is that possible?


On Donald Trump’s hit TV show, The Apprentice, contestants competed to be Trump’s chief apprentice. Predictably, each show ended when the field of contestants was narrowed down by the firing of a would-be apprentice. While the show was pure entertainment, we suspect Trump’s management style was on full display. Trump has run private organizations his entire career. Within these organizations, he had a tremendous amount of unilateral control. Unlike what is required in the role of President or that of a corporate executive for a public company, Trump largely did what he wanted to do.

On numerous occasions, Trump has claimed the stock market is his “mark-to-market.” In other words, the market is the barometer of his job performance. We think this is a ludicrous comment and one that the President will likely regret. He has made this comment on repeated occasions, leading us to conclude that, whether he believes it or not, he has tethered himself to the market as a gauge of performance in the mind of the public. We have little doubt that the President will do everything in his power to ensure the market does not make him look bad.

Warning Shots Across the Bow

On June 29, 2018, Trump’s Economic Advisor Lawrence Kudlow delivered a warning to Chairman Powell saying he hoped that the Federal Reserve (Fed) would raise interest rates “very slowly.”

Almost a month later we learned that Kudlow was not just speaking for himself but likely on behalf of his boss, Donald Trump. During an interview with CNBC, on July 20, 2018, the President expanded on Kudlow’s comments voicing concern with the Fed hiking interest rates. Trump told CNBC’s Joe Kernen that he does not approve [of rate hikes], even though he put a “very good man in” at the Fed referring to Chairman Jerome Powell.

“I’m not thrilled,” Trump added. “Because we go up and every time you go up they want to raise rates again. I don’t really — I am not happy about it. But at the same time I’m letting them do what they feel is best.”

“As of this moment, I would not see that this would be a big deal yet but on the other hand it is a danger sign,” he said.

Two months later in August of 2018, Bloomberg ran the following article:

Trump Said to Complain Powell Hasn’t Been Cheap-Money Fed Chair

“President Donald Trump said he expected Jerome Powell to be a cheap-money Fed chairman and lamented to wealthy Republican donors at a Hamptons fundraiser on Friday that his nominee instead raised interest rates, according to three people present.”

On October 10, 2018, following a 3% sell-off in the equity markets, CNBC reported on Donald Trump’s most harsh criticism of the Fed to date.  Trump said, “I think the Fed is making a mistake. They’re so tight. I think the Fed has gone crazy.”

Again-“I think the Fed has gone crazy

These comments and others come as the Fed is publicly stating their preference for multiple rate hikes and further balance sheet reduction in the coming 12-24 months. The markets, as discussed in our article Everyone Hears the Fed but Few are Listening, are not priced for the same expectations. This is becoming evident with the pickup in volatility in the stock and bond markets.  There is little doubt that a hawkish tone from Chairman Powell and other governors will increasingly wear on an equity market that is desperately dependent on ultra-low interest rates.

Who can stop the Fed?

We think there is an obstacle that might stand in the Fed’s way of further rate hikes and balance sheet reductions.

Consider a scenario where the stock market drops 20-25% or more, and the Fed continues raising rates and maintaining a hawkish tenor.

We believe this scenario is well within the realm of possibilities. Powell does not appear to be like Yellen, Bernanke or Greenspan with a finger on the trigger ready to support the markets at early signs of disruption. In his most recent press conference on September 26, 2018, Powell mentioned that the Fed would react to the stock market but only if the correction was both “significant” and “lasting.”

The word “significant” suggests he would need to see evidence of such a move causing financial instability. “Lasting” implies Powell’s reaction time to such instability will be much slower than his predecessors. Taken along with his 2013 comments that low rates and large-scale asset purchases (QE) “might drive excessive risk-taking or cause bubbles in financial assets and housing” further seems to support the notion that he would be slow to react.

Implications

President Trump’s ire over Fed policy will likely boil over if the Fed sits on their hands while the President’s popularity “mark-to-market” is deteriorating.

This leads us to a question of utmost importance. Can the President of the United States fire the Chairman of the Fed? If so, what might be the implications?

The answer to the first question is yes. Pedro da Costa of Business Insider wrote on this topic. In his article (link) he shared the following from the Federal Reserve Act (link):

Given that the President can fire the Fed Chairman for “cause” raises the question of implications were such an event to occur.  The Fed was organized as a politically independent entity. Congress designed it this way so that monetary policy would be based on what is best for the economy in the long run and not predicated on the short-term desires of the ruling political party and/or President.

Although a President has never fired a Fed Chairman since its inception in 1913, the Fed’s independence has been called into question numerous times. In the 1960’s, Lyndon Johnson is known to have physically pushed Fed Chairman William McChesney Martin around the Oval Office demanding that he ease policy. Martin acquiesced. In the months leading up to the 1972 election, Richard Nixon used a variety of methods including verbal threats and false leaks to the press to influence Arthur Burns toward a more dovish policy stance.

If hawkish Fed policy actions, as proposed above, result in a large market correction and Trump were to fire Fed Chairman Jerome Powell, it is plausible that the all-important veil of Fed independence would be pierced. Although pure conjecture, it does not seem unreasonable to consider what Trump might do in the event of a large and persistent market drawdown. Were he to replace the Fed chair with a more loyal “team player” willing to introduce even more drastic monetary actions than seen over the last ten years, it would certainly add complexity and risk to the economic outlook. The precedent for this was established when President Trump recently nominated former Richmond Fed advisor and economics professor Marvin Goodfriend to fill an open position on the Fed’s Board of Governors. Although Goodfriend has been critical of bond buying programs, “he (Goodfriend) has a radical willingness to embrace deeply negative rates.” –The Financial Times

Such a turn of events might initially be very favorable for equity markets, but would likely raise doubts about market values for many investors and raise serious questions about the integrity of the U.S. dollar. Lowering rates even further leaves the U.S. debt problem unchecked and potentially unleashes inflation, a highly toxic combination. A continuation of overly dovish policy would likely bolster further expansion of debt well beyond the nation’s ability to service it. Additionally, if inflation did move higher in response, bond markets would no doubt eventually respond by driving interest rates higher. The can may be kicked further but the consequences, both current and future, will become ever harsher.

Jerome Powell on 60 Minutes: Fact Check

On Sunday, March 11, 2019, Federal Reserve Chairman Jerome Powell was interviewed by Scott Pelley on 60 Minutes. We thought it would be helpful to cite a few sections of their conversation and provide you with prior articles in which we addressed the topics discussed.

We have been outspoken about the role of the Fed, their mission and policy actions over the last ten years. We are quick to point out flaws in Fed policy for a couple of reasons. First, is simply due to the enormous effect that Fed policy actions and words have on the markets. Second, many in the media seem to regurgitate the Fed’s actions and words without providing much context or critique of them. The combination of the Fed’s power over the market coupled with poor media analysis of their words and actions might expose investors to improper conclusions and therefore sub-optimal investment decision-making.

With that, we review various parts of the 60 Minutes interview and offer links to prior articles to help provide alternative views and insight as well as a more thorough context of Chairman Powell’s answers.  

Click the following links for the interview TRANSCRIPT and VIDEO.

Can the Fed Chairman be fired?

PELLEY: Do you listen to the president?

POWELL: I don’t comment on the president or any elected official.

PELLEY: Can the president fire you?

POWELL: Well, the law is clear that I have a four-year term. And I fully intend to serve it.

PELLEY: So no, in your view?

POWELL: No.

Our Take: Yes, the Federal Reserve Act which governs the Fed makes it clear that he can be fired “for cause.”- Chairman Powell You’re Fired

Does the Fed play a role in driving the growing income and wealth inequality gaps?

PELLEY: According to federal statistics, the upper half of the American people take home 90% of income, leaving about 10% for the lower half of Americans. Where are we headed in this country in terms of income disparity?

POWELL: Well, the Fed doesn’t have direct responsibility for these issues. But nonetheless, they’re important.

Our Take:  Inflation hurts the poor and benefits of the wealthy. The Fed has an inflation target and therefore takes direct policy action that fuels the wealth divide. – Two Percent for the One Percent

Will Chairman Powell know when a recession is upon us?

PELLEY: This is the longest expansion in American history. How long can it last?

POWELL: It will be the longest in a few months if it continues. I would just say there’s no reason why it can’t continue.

PELLEY: For years?

Our Take: In January of 2008 Chairman Bernanke said a recession was not in the cards. It turns out the official recession started a month earlier.– Recession Risks Are Likely Higher Than You Think

How healthy is the labor market?

POWELL: So, the U.S. economy right now is in a pretty good place. Unemployment is at a 50-year low.

Our Take: We continually hear about the strength of the labor market. While that may seem to be the case, wages and the labor participation rate paint a different picture. – Quick Take: Unemployment Anomaly (RIA Pro – Unlocked)

Do record high stock valuations represent healthy financial conditions?

PELLEY: We have seen big swings in the stock markets in the United States. And I wonder, do you think the markets today are overvalued?

POWELL: We don’t comment on the valuation of the stock market particularly. And we do though, we monitor financial conditions carefully. Our interest rate policy works through financial conditions. So we look at a very broad range of financial conditions. That includes interest rates, the level of the dollar, the availability of credit and also the stock market. So we look at a range of things. And I think we feel that conditions are generally healthy today.

Our Take: We beg to differ with over 100 years of history on our side. – Allocating on Blind Faith (RIA Pro – Unlocked)

Is the Fed Chairman aware of the burden of debt and its economic consequences?

PELLEY: But the overarching question is are we headed to a recession?

POWELL: The outlook for our economy, in my view, is a favorable one. It’s a positive one. I think growth this year will be slower than last year. Last year was the highest growth that we’ve experienced since the financial crisis, really in more than ten years. This year, I expect that growth will continue to be positive and continue to be at a healthy rate.

Our Take: The record amount of debt on an absolute basis and relative to economic activity is a burden on the economy. Expectations should be greatly tempered. – The Economic Consequences of Debt and Economic Theories – Debt Driven Realities

Does Chairman Powell bow at the altar of the President and Congress?

On December 17 & 18 of 2019 President Trump tweeted the following: 

“It is incredible that with a very strong dollar and virtually no inflation, the outside world blowing up around us, Paris is burning and China way down, the Fed is even considering yet another interest rate hike. Take the Victory!”

I hope the people over at the Fed will read today’s Wall Street Journal Editorial before they make yet another mistake. Also, don’t let the market become any more illiquid than it already is. Stop with the 50 B’s. Feel the market, don’t just go by meaningless numbers. Good luck!”

PELLEY: Your Fed is apolitical?

POWELL: Strictly non-political.

Considering the Fed made an abrupt U-Turn of policy following the Tweets above, a sharp market decline and very little change in the data to justify it, we think otherwise. – The Fed Doesn’t Target The Market

Summary

The Fed has a long history of talking out of both sides of their mouths. They make a habit of avoiding candor about policy uncertainties in what appears to be an effort to retain credibility and give an appearance of confidence. The Fed’s defense of their extraordinary actions over the past ten years and reluctance to normalize policy is awkward, to say the least and certainly not confidence inspiring. As evidenced by his responses to Scott Pelley on 60 Minutes, Jerome Powell is picking up where Bernanke and Yellen left off.

This article aims to contrast the inconsistencies of the most current words of the Fed Chairman with truths and reality. Thinking for oneself and taking nothing for granted remains the most powerful way to protect and compound wealth and avoid large losses.

Chairman Powell – You’re Fired

I’m a low interest rate person – Donald Trump 2016

On Donald Trump’s hit TV show, The Apprentice, contestants competed to be Trump’s chief apprentice. Predictably, each show ended when the field of contestants was narrowed down by the firing of a would-be apprentice. While the show was pure entertainment, we suspect Trump’s management style was on full display. Trump has run private organizations his entire career. Within these organizations, he had a tremendous amount of unilateral control. Unlike what is required in the role of President or that of a corporate executive for a public company, Trump largely did what he wanted to do.

On numerous occasions, Trump has claimed the stock market is his “mark-to-market.” In other words, the market is the barometer of his job performance. We think this is a ludicrous comment and one that the President will likely regret. He has made this comment on repeated occasions, leading us to conclude that, whether he believes it or not, he has tethered himself to the market as a gauge of performance in the mind of the public. We have little doubt that the President will do everything in his power to ensure the market does not make him look bad.

Warning Shots Across the Bow

On June 29, 2018, Trump’s Economic Advisor Lawrence Kudlow delivered a warning to Chairman Powell saying he hoped that the Federal Reserve (Fed) would raise interest rates “very slowly.”

Almost a month later we learned that Kudlow was not just speaking for himself but likely on behalf of his boss, Donald Trump. During an interview with CNBC, on July 20, 2018, the President expanded on Kudlow’s comments voicing concern with the Fed hiking interest rates. Trump told CNBC’s Joe Kernen that he does not approve [of rate hikes], even though he put a “very good man in” at the Fed referring to Chairman Jerome Powell.

“I’m not thrilled,” Trump added. “Because we go up and every time you go up they want to raise rates again. I don’t really — I am not happy about it. But at the same time I’m letting them do what they feel is best.”

“As of this moment, I would not see that this would be a big deal yet but on the other hand it is a danger sign,” he said.

Two months later in August of 2018, Bloomberg ran the following article:

Trump Said to Complain Powell Hasn’t Been Cheap-Money Fed Chair

“President Donald Trump said he expected Jerome Powell to be a cheap-money Fed chairman and lamented to wealthy Republican donors at a Hamptons fundraiser on Friday that his nominee instead raised interest rates, according to three people present.”

On October 10, 2018, following a 3% sell-off in the equity markets, CNBC reported on Donald Trump’s most harsh criticism of the Fed to date.  Trump said, “I think the Fed is making a mistake. They’re so tight. I think the Fed has gone crazy.”

Again-“I think the Fed has gone crazy

These comments and others come as the Fed is publicly stating their preference for multiple rate hikes and further balance sheet reduction in the coming 12-24 months. The markets, as discussed in our article Everyone Hears the Fed but Few are Listening, are not priced for the same expectations. This is becoming evident with the pickup in volatility in the stock and bond markets.  There is little doubt that a hawkish tone from Chairman Powell and other governors will increasingly wear on an equity market that is desperately dependent on ultra-low interest rates.

Who can stop the Fed?

We think there is an obstacle that might stand in the Fed’s way of further rate hikes and balance sheet reductions.

Consider a scenario where the stock market drops 20-25% or more, and the Fed continues raising rates and maintaining a hawkish tenor.

We believe this scenario is well within the realm of possibilities. Powell does not appear to be like Yellen, Bernanke or Greenspan with a finger on the trigger ready to support the markets at early signs of disruption. In his most recent press conference on September 26, 2018, Powell mentioned that the Fed would react to the stock market but only if the correction was both “significant” and “lasting.”

The word “significant” suggests he would need to see evidence of such a move causing financial instability. “Lasting” implies Powell’s reaction time to such instability will be much slower than his predecessors. Taken along with his 2013 comments that low rates and large-scale asset purchases (QE) “might drive excessive risk-taking or cause bubbles in financial assets and housing” further seems to support the notion that he would be slow to react.

Implications

President Trump’s ire over Fed policy will likely boil over if the Fed sits on their hands while the President’s popularity “mark-to-market” is deteriorating.

This leads us to a question of utmost importance. Can the President of the United States fire the Chairman of the Fed? If so, what might be the implications?

The answer to the first question is yes. Pedro da Costa of Business Insider wrote on this topic. In his article (link) he shared the following from the Federal Reserve Act (link):

Given that the President can fire the Fed Chairman for “cause” raises the question of implications were such an event to occur.  The Fed was organized as a politically independent entity. Congress designed it this way so that monetary policy would be based on what is best for the economy in the long run and not predicated on the short-term desires of the ruling political party and/or President.

Although a President has never fired a Fed Chairman since its inception in 1913, the Fed’s independence has been called into question numerous times. In the 1960’s, Lyndon Johnson is known to have physically pushed Fed Chairman William McChesney Martin around the Oval Office demanding that he ease policy. Martin acquiesced. In the months leading up to the 1972 election, Richard Nixon used a variety of methods including verbal threats and false leaks to the press to influence Arthur Burns toward a more dovish policy stance.

If hawkish Fed policy actions, as proposed above, result in a large market correction and Trump were to fire Fed Chairman Jerome Powell, it is plausible that the all-important veil of Fed independence would be pierced. Although pure conjecture, it does not seem unreasonable to consider what Trump might do in the event of a large and persistent market drawdown. Were he to replace the Fed chair with a more loyal “team player” willing to introduce even more drastic monetary actions than seen over the last ten years, it would certainly add complexity and risk to the economic outlook. The precedent for this was established when President Trump recently nominated former Richmond Fed advisor and economics professor Marvin Goodfriend to fill an open position on the Fed’s Board of Governors. Although Goodfriend has been critical of bond buying programs, “he (Goodfriend) has a radical willingness to embrace deeply negative rates.” –The Financial Times

Such a turn of events might initially be very favorable for equity markets, but would likely raise doubts about market values for many investors and raise serious questions about the integrity of the U.S. dollar. Lowering rates even further leaves the U.S. debt problem unchecked and potentially unleashes inflation, a highly toxic combination. A continuation of overly dovish policy would likely bolster further expansion of debt well beyond the nation’s ability to service it. Additionally, if inflation did move higher in response, bond markets would no doubt eventually respond by driving interest rates higher. The can may be kicked further but the consequences, both current and future, will become ever harsher.

The 2016 State Of The Union

Tomorrow night, the President Obama will deliver his final annual “State Of The Union” address. Just recently, the President gave a preview of his upcoming speech from the White House.

While Obama promises to frame his speech around the “things we need to do over the years to come,” he will use his bully pulpit to focus on his record of achievements (especially those related to the environment and trade) and push for further restrictions on gun ownership.

With the 2016 Presidential Election fast approaching, this is one of the final chances the White House will have to give a boost to the Democratic voters following the beating they took in the 2012 mid-term elections. The message sent then, even by traditionally Democratic states which elected conservative representatives, was of a broad loss of faith in “hope and change.”

For the Democratic party, it is imperative to regain those votes. It is from this priority that the President will paint a decisively positive economic picture during his upcoming speech. He hopes that by pointing to a falling unemployment rates, economic growth and higher confidence levels; it will give voters a sense of confidence in the President’s accomplishments.

The question is whether the majority of the voting public will agree with the President’s message?

Before the President takes to the podium with his bullish optimism, he might want to consider the following charts.


Government Debt

Since 2009, Government debt has surged by $7.75 Trillion and by the end of the next budget cycle will approach $20 Trillion in total. The problem is that during the current Presidential term, real economic growth has risen by just $2.08 Trillion. However, even this number is inaccurate as the current government debt levels do not include other liabilities of the government such as social security and other social welfare programs.

Debt-vs-EconomicGrowth-011116

The following chart quantifies it a bit better when you look at cumulative increases in debt and real, inflation adjusted, GDP.

Debt-GDP-GrowthRatio-011116

Yes, the economy is growing, however, that growth has come at a huge cost of a debt burden that will be amplified if borrowing costs rise with increases in interest rates. Furthermore, considering that President Obama admonished the previous administration’s increase in debt, the explosion in the amount of debt required to generate economic growth (currently $3.71) is unsustainable longer term.

Employment

The President will address the recent employment report and point to a 5.0% unemployment rate as evidence that the economy “is back.” While the current Bureau of Labor Statistics employment reports do currently show the unemployment rate at 5.0%, that number is obfuscated by the more than 93 million workers that are currently not counted as part of the labor force.

As I have discussed many times previously, when it comes to economic strength it is full-time labor that leads to household formation and higher consumption.

Furthermore, the rate of employment must be faster than the rate of population growth, otherwise, you are just treading water. The chart below shows the amount of full-time labor as a ratio of the working age population.

Employment-FullTime-Pop-President-011116

Currently, 49.23% of the population is employed full-time which is a rate lower than when the President entered office. Furthermore, as noted above, the employment ratios are deceiving when you realize that the population has grown faster than employment leaving a rising number of individuals no longer counted as part of the labor force.

Employment-PopGrowth-Jobs-011116

NILF-President-011116

Importantly, when the employment-to-population ratio or the labor-force participation rate is discussed, the plunging levels in these ratios are often dismissed simply as a function of the “baby boomers” heading into retirement. However, if we factor out those individuals by only looking at the employee-to-population ratio of 16-54 aged individuals as a percent of that age group the picture fails to improve.

Employment-WorkingAgePop-011116

While the unemployment rate has certainly plunged to just 5.0%, one would be hard pressed to find 95.0% of the population that “wants to work,” actually working.

Personal Incomes

The annual rate of change in personal incomes has been on a decline since the turn of the century.  This is a function of both the structural shift in employment (higher productivity = less employment and lower wage growth) and the drive to increase corporate profitability in the midst of weaker consumption.

The chart below shows the disparity between corporate profits and employment and wages.

Wages-Profits-Ratios-011116

While corporate profitability has surged since the financial crisis, those profits have come at the expense of employees. Since 2009, wages for “non-supervisory employees,” which is roughly 80% of the current workforce has been on a steady decline.

Wage-Growth-NonSupervisory-011116

The problem with this, of course, is that the real cost of living continues to rise.

Government Assistance

Of course, the issue of declining incomes and rising “income inequality” is really best shown by the level of social benefits as a percentage of disposable incomes today. Today, roughly 1-in-3 households receive some form of government assistance.

Government-Asst-DPI-011116

It is here that the President will be most challenged in presenting his “economic” story. While he will point to rising asset prices, improved headline employment numbers and economic growth as reasons to be “optimistic,” with almost 80% of the country living roughly paycheck-to-paycheck it will be a hard argument to win.

Housing

When it comes to the economy, it is home ownership that is the reflection of economic well-being. Since 2009, the government has poured trillions of taxpayer dollars into the housing market to try and increase activity. The effect of those injections has been marginal to say the least.

Housing-TotalActivity-Index-011116

However, as I stated above, it is ultimately household formation that leads to higher levels of consumption and stronger economic growth. The current recovery, as shown by the chart below, was NOT driven by individuals buying homes to live in, but rather speculators buying homes, primarily for cash, and turning them into rentals. With homeownership currently near its lowest levels since the early 1980’s, it does not suggest a resurgent economy is in the making.

Home-Ownership-011116

Economic Prosperity

However, it is the economic prosperity of an individual that truly determines how they will vote at the polls. A recent Fed Reserve survey of consumer finances shows the real disconnect between Wall Street and Main Street economics.

4-Panel-Prosperity-011215

With net worth, incomes, financial assets and business equity ownership at levels substantially below where they were when the President took office, it is not surprising that the Administration is focused on trying to justify their record.

While the data, as reported by government agencies, has been massaged, tweaked, and recalibrated to provide more optimistic output, it is hard to fudge the economic standards by which the majority of the country lives with. Like a game of “Civilization,” the recent mid-term elections sent a pretty clear message that the “serfs” are not happy in the “kingdom.”

Defining The State Of The Union

While the President will do his best to put a positive spin on the current economic environment, and the success of his policies, when he gives his “State of the Union” address, it would be worth remembering whom he is actually addressing.

It is also worth considering that much of this is likely the reason that Donald Trump is surging in Conservative polling.

As with all things – it is the lens from which you view the world that defines what you see. For Wall Street, things could not be better. For Main Street, most everything could be better. The President has a lot of “convincing” to do if he expects to change voter’s attitudes between now and the 2016 Presidential election.

Lance Roberts

lance_sig

Lance Roberts is a Chief Portfolio Strategist/Economist for Clarity Financial. He is also the host of “The Lance Roberts Show” and Chief Editor of the “Real Investment Advice” website and author of “Real Investment Daily” blog and “Real Investment Report“. Follow Lance on Facebook, Twitter and Linked-In