HOPES that the Federal Reserve will rescue the bull market from the trade war may be dashed this week, with the central bank’s hands likely tied by the inflation risks accompanying tariffs.
For the second straight meeting, the Fed is likely to keep rates steady in a range between 4.25 and 4.5 per cent in its policy statement on Wednesday (Mar 19).
After a slump in global stock and bond markets, major US equity indexes have crept higher ahead of the Fed meeting. After dipping into correction territory and closing Thursday more than 10 per cent below its February record high, the S&P 500 gained back more than 2 per cent on Friday.
That’s because consumer and wholesale inflation data appear to be back on track to meet the Fed’s 2 per cent annualised target rate, and consumer spending data suggested economic growth may be slowing. Those two factors combined, the bullish traders hoped, would lead Fed chair Jerome Powell to change his “wait and see” stance and begin preparing the ground for a rate cut.
Unfortunately, the Fed is likely to interpret recent economic data differently to conventional Wall Street wisdom.
“Recession risks have overtaken stagflation risks, leaving markets confused,” said economists at brokerage BNP Paribas, in a note to clients. “We think the March FOMC (Federal Open Market Committee) meeting – like the December FOMC meeting – might not share the market’s view that growth risks are dominating inflation risks and instead bring back focus on heightened inflation fears.”
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The BNP economists say the Fed may find a dark lining to the silver clouds of personal-consumption expenditure data. While rents and fuel prices have alleviated pressures on consumers, product prices are now inching higher again. Tariffs on steel and aluminium have already pushed up prices of the industrial metal, and economists say this will inevitably lead to higher prices. Even Tesla, run by one of Trump’s advisers, Elon Musk, has warned that tariffs will drive up its cost of production.
As the tit-for-tat duties spread to food, alcohol and other categories, the trade war could bring on a new wave of inflation. Even if the economy enters recession, as seems to be increasingly likely based on warnings of slowing demand from airlines and other economic bellwethers, the central bank could not loosen its monetary policy if prices were rising.
“Trade and tariff policy changes are coming sooner and more forcefully than previously expected,” warned strategists at brokerage Morgan Stanley, in a note to clients. “Even without a recession…a slower pace of economic growth and higher level of policy uncertainty” has emerged, the strategists wrote.
The BNP economists anticipate the Fed’s economic projections will, for the first time, include concrete references to “tariff-fuelled” inflation risks alongside acknowledgment of slowing US economic activity.
The stock market is likely to come under pressure as traders realise there are no longer any safety nets provided by policymakers.
The “Trump put”, the idea that President Donald Trump would alter plans if he saw the stock market crumble, vanished last week, said JD Joyce, president of Houston financial advisory Joyce Wealth Management.
Administration officials, including Treasury Secretary Scott Bessent, said the escalating, multi-front trade war with China, Mexico, Canada and the European Union was a long-term strategy, worth the short-term economic pain. Trump even suggested his government would weather a recession before backing off demands for fair trade.
Before there was the Trump put, there was the “Fed put”. Since the days of Alan Greenspan, in the 1990s, the understanding has been that the stock market has an inviolable safety net in the central bank. That’s because, for 40 years, the biggest risks to the economy have been recession rather than inflation. The deeper the recession, the more aggressive the central bank could afford to be with rate cuts. And rate cuts have never failed to revive the stock market.
On Wednesday, Powell may have to deliver some bracing news: the post-pandemic era of inflation may have been extended by the trade war. And that means the Fed is powerless to stave off recession and save the bull market.
