The border wall and the Fed’s reaction function

Two issues I mentioned yesterday need some clarification.

Trump will declare a state of emergency for the Wall

The first is the shutdown. It’s this quote that needs clarification:

The longer the shutdown goes on, the more damage it will do. I see Trump caving eventually. If he doesn’t, he will take huge knocks for his economic stewardship. And while the Congressional Democrats will also get some of the blame, it is Trump who has most to lose here, since the economy is his best issue.

Trump doesn’t have to climb down in terms of actually negotiating an agreement. More likely, he will simply declare a state of emergency as I tweeted a few days ago when I heard he was going to Texas on Thursday.

Trump’s televised formal address on Tuesday was just Kabuki theater. And the networks bought into it by televising it. He was just laying the groundwork for the state of emergency he planned to call by making the rhetorical case to the nation because he needs the shutdown to end and he wants his wall to get built.

Here’s the Times of London:

President Trump said during a visit to the Mexican border yesterday that he would “almost definitely” declare a state of emergency to secure funds for a wall if he could not reach agreement with the Democrats.

His strongest threat to bypass Congress came the day after he walked out of talks with Democratic leaders when Nancy Pelosi, the Speaker of the House, refused to release any cash for the wall.

The failure to sign off on annual funding legislation has left the US government facing its longest partial shutdown. It will pass the 21 days under President Clinton if it continues into tomorrow, with 800,000 workers due to miss out on their pay cheques today.

Will this work? I don’t know. But, he has now stated emphatically that this is where it’s headed.

The Fed is still more hawkish than you think

I have been saying that the market took a ‘Fight the Fed’ tone in December to victory, forcing the Fed to climb down from its three rate hike view for 2019. But, now the markets think they have won the war. They haven’t.

In the piece by Binyamin Appelbaum I quoted from yesterday, there is a clue via Boston Fed President Eric Rosengren, who, like Lael Brainard, was a dove that has turned more hawkish. Here’s the quote:

Eric Rosengren, the president of the Federal Reserve Bank of Boston, told a Boston audience that the Fed was puzzling through the recent divergence between strong economic data and faltering financial markets.

“At this juncture, with two very different scenarios — economic slowdown implied by financial markets; or growth somewhat above potential G.D.P. growth, consistent with economic forecasts — I believe we can wait for greater clarity before adjusting policy,” he said.

Notice that what he is saying is that the economic data are good. He’s also saying that the Fed is only pausing because markets are forcing them to do so. If the Fed’s read – that the data actually are still good – continues to be true, the Fed will indeed hike rates in 2019, once the markets settle down. That’s the message. It’s more hawkish than the markets think it is.

And while St. Louis Fed President Bullard is quoted in the same piece saying the Fed is “bordering on going too far and possibly tipping the economy into recession,” I think this is a minority view. The tell is the quote by Chicago Fed President Evans, who says “I feel we have good capacity to wait and carefully take stock of the incoming data and other developments.” He’s saying what Rosengren is saying: wait for markets to calm and for the data to come in and then reassess. This is classic data dependency at work.

My view

I expect the data to be good for Q4. Yes, Q1 growth is projected to be lower than Q4 2018 was. And the shutdown has prognosticators at JPMorgan taking it even lower. But, that’s always been the projection at the Fed, moderately slowing growth in 2019. And, that’s still good enough to get the first of two rate increases by April or June.

You have now officially been warned!


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