1 Big Idea: Trump owns the economy, Congressional Republicans don’t
One story that didn’t make it in to Yesterday’s daily post was about Republicans downplaying the booming economy on the campaign trail. Here’s what the New York Times is saying:
His Republican opponent doesn’t say much publicly about the Trump tax cuts, but on a warm night in a small-town union hall an hour outside Columbus, Danny O’Connor was happy to talk about them — a lot.
“We just saw, this last December, a $2 trillion swipe of the national credit card, a giveaway to big corporations,” Mr. O’Connor, the Democrat in a special election on Aug. 7 for an open congressional seat here, told the crowd, drawing nods. “That doesn’t do anything for us. It doesn’t do anything for working people.”
Why this matters: With the midterm elections coming up, you would think a booming economy would offer a tailwind for incumbent Republican candidates. But it doesn’t. And so they aren’t talking about it.
What this lack of economic triumphalism says is that many Americans are still hurting. Remember how the Bureau of Economic Analysis boosted the personal savings rate when GDP figures were released on Friday. This tidbit says we are right to question the narrative that surrounded that adjustment. It still seems that a lot of people are living paycheck to paycheck.
Deeper analysis: So when we see the Trump Administration floating the idea of adjusting capital gains taxes for inflation, we should keep this in mind. That adjustment will go to the highest earners, but do nothing for those living paycheck to paycheck.
If the Trump Administration goes through with this capital gains idea, it will put more pressure on Congressional Republicans to explain how their policies help ordinary Americans. And Democratic candidates will point to the deficit from these additional tax breaks and say it will end up as cuts in social programs. And that may be a compelling argument.
My take: I don’t have a strong view here. I do think the economy is doing well. I don’t know how well families hurt by the last recession are doing and whether a strong economy message resonates with them. But I think the tax cuts will remain unpopular and that makes talking about the booming economy hard for Republican candidates since the economy and the tax cuts are inextricably linked.
2. Trump tries to wrest party control from free traders
Although Trump has said he plans to campaign six days a week for Republican candidates this fall, it is questionable whether doing so would help. Moreover, it is equally questionable whether Trump’s protectionist bent is leading to a schism in his party.
The Koch Network is now criticizing him over trade. They say, tariffs could lead to recession in a worst case scenario. But if you read the accounts of the criticism, you can see they are measured, with some praise in other areas of policy.
But Trump has taken the criticism poorly and has lashed out at the Kochs on Twitter.
Why this matters: Trump is attempting to re-make the Republican Party in his image. He will broker no dissent as he tries to move the party in his direction. And so he sees the Koch Brothers’ agenda as a threat to his control. If he can marginalize them, it will send a big signal to other Republicans to toe the Trump line or face severe consequences.
As the Kochs are non-politicians who are rich and influential in Republican circles, they don’t have to face voters. So Trump has less leverage over them. Nevertheless, if he can successfully move the Party away from their free trade agenda, then consider the Republicans to be Trump’s Party because he will be able to lord over it without any dissent.
3. Companies passing through trade war costs to customers
This comes from the New York Times:
The Trump administration’s tariffs have pushed up the prices of steel and aluminum and have raised costs for companies that make everything from cars and tractors to dishwashers. These companies face a choice. They can bear the higher costs themselves and report weaker profits, which might crater their stocks. Or they can charge more for their products, in effect making their customers bear much of the financial burden of the tariffs, at least for a while.
Many companies are opting for the latter.
As they report second-quarter earnings, they are going out of their way to let their shareholders know that it is customers who are paying.
Why this matters: At the margin this should cause the Fed to accelerate its rate hike path. The Fed’s preferred measure of inflation is finally at its target of 2%. And even though the Fed says it is comfortable with a mild overshoot, it will still work to keep inflation pressures in check.
4. The Fed is now on a four hike path for 2018
Reuters writes up their Fed meeting preview as if four rate hikes is a foregone conclusion.
The Federal Reserve is expected to keep interest rates unchanged on Wednesday but solid economic growth combined with rising inflation are likely keep it on track for another two hikes this year even as President Donald Trump has ramped up criticism of its push to raise rates.
I think that’s right. My friend Pedro da Costa noted yesterday that due to Bill Dudley’s departure at the New York Fed and San Francisco Fed President John Williams’ replacement of him, KC Fed President Esther George is now a voting member of the FOMC. She is a noted hawk. And so, again, at the margin, replacing a Dudley vote with a George vote makes four rate hikes more likely.
Why this matters: the last time we heard from the Fed, they put forward a summary of economic projections chart that had the rate hike path finely balanced between three and four this year. The scales had tipped toward four, but only marginally. I expect the scales to tip even more toward four in this upcoming meeting.
5. Curve flattening has paused but the debate surrounding it hasn’t
After the market took the differential between the 2-year Treasury yield and the 10-year yield down to below 25 basis points, curve flattening has stopped. Right now we are at about 28 basis points. And I think we will stay in that range for some time.
Why this matters: As the Fed hikes, it will be less worried about inverting the curve given where we are now. Again, at the margin, this makes the Fed more hawkish. But it also gives false comfort to those who find a flattening yield curve nothing to worry about. Burton Malkiel is the latest to espouse this view. He wrote in the Wall Street Journal yesterday about inversion:
Recently, the curve has become noticeably flatter, with short-term rates rising and longer yields remaining stagnant. This has led many analysts to think that the curve will soon invert. But that does not mean a recession is imminent…
I do not mean to imply that we have nothing to worry about with respect to either the economy or the stock market. The prospect of a global trade war should make us very cautious. Once we start down the road of tariff increases and threats of more to come, the dangers of retaliatory miscalculations are very real and very scary. But a flat yield curve, or even an inverted one, should not be on top of our worry list under today’s accommodative monetary conditions.
Deeper analysis: This is exactly the kind of thinking we see at the Fed. What they’re saying is that these market signals are not predictive but suggestive. And while we will watch them, they will not preclude us from increasing our monetary tightening.
Ostensibly then, the Fed is looking at real economy signals to make a determination as to whether it should continue to tighten and by how much. But they risk overtightening, particularly because they might read credit excess as a sign of overheating rather than as a reaction to rising rates by debtors looking to avoid higher interest payments. That’s late cycle behavior which can fool the Fed into thinking the economy is more robust than it is.
6. What about the economy?
In terms of the actual economy, there are a number of different factors that say the expansion has legs. Here are a few threads I have picked up in that vein on over the last couple of days. Let’s look at things globally
- Yields on the lowest-rated U.S. junk bonds fell by the most since 2008 yesterday, falling to the lowest since 2014. – Lisa Abramowicz, Bloomberg. Now, a contrarian could say that makes them ripe for a reversal. But I don’t think that reversal is coming just yet given all of the money pouring into private equity that I mentioned yesterday.
- In Japan, the Bank of Japan governor has decided not to wind down his monetary stimulus, as was widely expected. Today, he announced a commitment to “continuous powerful monetary easing”. The Yen fell on the announcement, as did long-term Japanese interest rates.
- In Europe, economic growth unexpectedly slowed, with Q2 coming in at 0.3%, below the 0.4% growth number expected. Unemployment, though, is at the lowest levels since 2008. And that’s enough to expect the ECB to begin to pull back from its monetary accommodation later in the year.
- In EM, Turkey continues to be a bad portent. The Turkish Lira has continued to fall even as 10-year Turkish yields have hit fresh new highs. “The Turkish central bank on Tuesday sharply hiked its inflation forecast for 2018 to well over 13 percent, putting new pressure on the embattled lira and raising fears over the extent of price pressure in the economy… Since January the lira has lost over 23 percent of its value against the dollar.”
Why this matters: yes, there are cracks in the armour, notably in Turkey. But the problems in the global economy are not enough to believe this expansion is ending anytime soon. 2018 may be a period of uncertainty politically. Nevertheless, the economic uncertainty won’t really grow until 2019.
Update 1142 EDT: One factoid that I failed to mention regarding the economy when I first wrote this post is the poor data that precipitated the Japanese caution on pulling back on monetary stimulus. Here’s the FT yesterday:
Industrial production in Japan dropped 2.1 per cent month-on-month in June, according to data from the Ministry of Economy, Trade and Industry.
That missed analysts’ expectations of a 0.4 per cent decline and followed a 0.2 per cent monthly dip in May, according to Reuters data.
The Japanese government says it’s not concerned because “industrial production is picking up slowly”. But this is pretty weak. And it explains why we are geting more stimulus.