Trump versus the Fed: redux

Trump versus the Fed: redux

President Trump keeps badgering the Fed’s Jay Powell to lower interest rates. He has even threatened to “fire” Powell. Pardon me for being confused. Doesn’t the president know that if the Fed lowers interest rates, the cost of financing the debt is likely to rise? After the Open Market Committee met in May, the headlines blared that the “Fed keeps interest rates unchanged!” Well if that is true then why did the Treasury bond rates go up? More on that later.

First, why insist that Powell lower interest rates? It is the Fed’s Open Market Committee that makes these decisions. The Fed chair – although the most important member of the committee – has to convince the other eleven members to support his position. That committee zealously guards its independence, as does the chairman. Maybe Trump wants to fire the entire committee. But since the reserve banks are private corporations, Trump cannot fire the reserve bank presidents. Trump’s tweeting vindictives only makes the committee dig in its heels to tell the president to go pound sand. Of course, Trump could threaten to fire the entire Board of Governors – much like he has done with two of the three members of the National Credit Union Administration board. But there would be an adverse market reaction and Trump would likely lose in court given the Humphrey’s ruling by the Supreme Court.

Second, the Fed operates in the short end of the Treasury market. Lowering its fed funds rate may lead to other short term rates falling but it will be at the price of an increase in the money supply. The result would be higher inflation. Does Trump really want to see prices rise even more than they are rising given his tariff policies? The threat of higher inflation will then lead to an increase in bond yields as long term investors protect the real value of their investments. It is this threat that is contributing to the rise in the yields of Treasury bonds. Trump’s policies have caused both the 20 Treasury and the 30 year Treasury to climb over 5 percent. So isn’t it ironic that Trump’s policies also make financing the national debt more expensive? Thus, if the Fed did lower short term rates it would increase inflationary expectations and then lead to an increase in the yields on Treasury bonds and increasing the national debt burden. Surely if Trump doesn’t know this, his so-called economic advisors should – although that may be doubtful since they were educated at Harvard.

The Fed’s Open Market Committee met in May and has voiced concerns that the tariffs will be inflationary. The committee said “Participants agreed that uncertainty about the economic outlook had increased further, making it appropriate to take a cautious approach until the net economic effects of the array of changes to government policies become clearer.” Translation to Trump: go pound sand. The committee meets again in June and is taking a wait and see attitude. The indication is that they are in no hurry to fool around with rates. In fact, Fed officials have uniformly said that the committee is setting a very high bar with regard to changing rates. Fed economists have lowered their forecast for economic growth and increased their inflation forecast. It is probably a bridge too far to ask the president to shut up. But shut up he should. His policies are creating uncertainty in financial markets. His policies are creating inflation and unemployment. A decrease in interest rates by the Fed will exacerbate the problems, not ease them. But what me worry? Trump will try to blame any of his economic difficulties on the Fed. But I have the feeling that the public will know who is really to blame.

By the way, I am one of many who cringes when it is said that the Fed keeps “interest rates unchanged”. Obviously interest rates change daily. What is unchanged in the target range of the Fed funds rate. Again, the fed funds rate is the rate that the Fed charges on fed funds which are excess reserves traded in the banking system overnight. Currently, it is set at 4.33% within the target range of 4.25 – 4.50 percent.

I know there are Fed haters out there – that includes one of my good friends. However, what’s the alternative? Do you really want the Fed subservient to the wishes of the politicians who know little about economics and seem to care less of its consequences. Again, the only law that politicians rush to repeal is the law of supply and demand. Thus far, the politicians have always lost.