Federal Reserve Chair Jerome Powell seems to be in a highly precarious seat at the moment, one that is envied by few.
Last year he was bullied by President Trump, who said he was unworthy or a "bad choice," suggesting he was "crazy" to keep raising interest rates. This year investors have jumped on the bandwagon demanding he cut rates by collapsing the yields across the U.S. Treasury and rates market.
The media did not do any justice to the Fed, which was clearly monitoring the data to see if the economy merited a rate-hike pause. If one were to look at the 12-month forward Fed hikes future dot plots vs. the OIS pricing of fed funds (as implied by the market), the gap is the widest since the data has ever been published.
Will Powell acquiesce to Trump and/or market pressure and negate the Fed's real job mandate? That remains to be seen.
The Fed's June FOMC meeting is this week, concluding on June 19. One thing is clear, the market is expecting a rate cut or at least a very seriously dovish message. This is evident in all asset classes from the U.S. dollar to bonds to rates.
In 2018, when the Fed was on a constructive path to draining the economy of the excess liquidity pumped in over the past decade, the U.S.-China trade wars began in the summer. Since then the market has fluctuated amid uncertainty, but with the economy growing close to 3%, and unemployment at record lows, it is no wonder the Fed did not change its view. The central bank did succumb a bit, it seems, to presidential pressure as the market collapsed in the fourth quarter when it decided to do "what it takes" to sustain the expansion.
As the market rallied aggressively from the lows of late last year in addition to Chinese bank stimulus in the first quarter of 2019, Trump is once again rattling the cage by demanding China agree to U.S. demands and change its domestic policy on top of balancing its trade deficit with the U.S. The market is showing signs of tipping into a recession, but Trump is very bold about pointing the finger at the Fed, which he believes is the reason behind it.
I believe if it were up to Trump, he would have rates at negative, embark on QE4 and 5 and keep going, and re-lever the economy to the nth degree without any consequences, just so he can see the stock market higher and get re-elected. Asset price inflation does not a great economy make.
The probability of a rate cut in July is trading close to 85%, and 61% for close to three rate cuts until the end of this year. It is quite remarkable to see such an aggressive outcome priced in by the market given we are close to trading near all-time highs in most U.S equity indices.
U.S growth is slowing but the jury is out as seen in the recent retail sales data. Global economic growth is a lot worse, no doubt. The Fed just looks at the data for signals, it does not care what the market says. It needs the justification from the data to be able to cut -- it does not have that green light yet.
Let's consider the Fed's choices.
Trump and President Xi Jinping will potentially meet at the G20 meeting on June 28, after the Fed deliberates. So the Fed will not have enough data or know how the U.S./China trade war will proceed to be able to make a decision yet.
It is prudent for the Fed to wait until July, if it needs to do anything at all. If the Fed cuts now and gives in to market pressure, it will spook the market wondering what the central bank knows.
The smart and sensible thing to do would be to keep things as is, remain patient and say further data monitoring is warranted. If that is the outcome of this Fed meeting, no doubt the U.S. dollar will rally and bond markets fall as markets will need to recalibrate just how much of a cut has been priced in. It will serve the Fed well to wait as, if need be, it can potentially cut rates by 50 basis points in September as the trade war and state of the global economy unfolds.
Do not expect any fireworks or an agreement at the G20. If a deal is announced, no doubt the market could have a huge relief rally, but make no mistake, the bond market will sell off hard and the dollar rally, which may not be good for commodities eventually. Given the harsh words and strong demands exchanged on both sides, the most likely outcome is for talks to continue.
There is a high chance that the trade wars will continue well into next year given the timing of the presidential campaign, with a deal likely close to election time. If that were to happen, sell-side analysis still need to price in lower earnings estimates for the tariffs currently in place and higher cost to companies. Most analysts still do not believe these problems are here to stay, and that either the Fed will magically fix things or China will give in. That's wishful thinking.