Even the oil and gas sector, which Trump urged to “drill, baby, drill”, is laying off employees and reducing its drilling activity in an environment of subdued oil prices – an environment coloured by the impacts of Trump’s trade wars on global trade and growth.
None of this was unexpected and almost all of it – if not all of it – relates directly to Trump’s policies.
Trump’s tariffs are raising the input costs of manufacturers while generating considerable uncertainty.Credit: Bloomberg
The US economy grew 2.8 per cent last year and, while it slowed towards the end of the year, was still growing at 2.4 per cent in the December quarter. It’s now growing at an annualised rate of 1.4 per cent.
US inflation was falling steadily last year. It’s edging up even before the full effect of the tariffs has had time to flow through to the data.
The latest data on consumer and producer inflation will be released this week. It is expected to show that core inflation (excluding volatile food and energy prices) was still well above the Fed’s target of 2 per cent last month. The Fed’s preferred gauge, the core personal consumption expenditures index, rose 0.3 percentage points to 2.9 per cent in July.
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It was expected, and forecast widely, that Trump’s policies would lead to reduced employment growth, less business activity and higher inflation because of their impacts on costs and prices, confidence and the supply and demand for labour.
At their last meeting in December, before Trump regained the US presidency, the Fed’s Open Market Committee forecast GDP growth of 2.1 per cent for this year, an unemployment rate of 4.3 per cent, and a core inflation rate of 2.5 per cent.
At their March meeting, GDP growth was revised down to 1.7 per cent, the unemployment rate to 4.4 per cent, and the inflation rate to 2.8 per cent. Then, in June, those numbers were again amended, with expected GDP growth downgraded to 1.4 per cent, the unemployment rate raised to 4.5 per cent, and the inflation rate to 3.1 per cent.
The Fed’s chair, and Trump’s bete noire, Jerome Powell, has made no secret of the rationale for the changes in expectations. They have occurred in response to the expected effects of Trump’s trade and immigration policies on inflation and employment.
The Open Market Committee meets again next week and it is widely expected that it will cut its policy rate, the federal funds rate, by 25 basis points – the markets say there is a 90 per cent probability. It would be the year’s first rate cut after total cuts of a percentage point last year.
That cut, if it eventuates, would be directly related to the weak jobs numbers. While some in the markets are calling for a 50 basis point cut (Trump wants three percentage points), the Fed’s concern about a rising inflation rate has tended to make it cautious.
The tariffs have been rolled out in haphazard fashion, with the reciprocal tariffs on imports from 90-odd countries taking effect from August 7. Various sectoral tariffs have been imposed since February, with more in the pipeline.
It may take until well into next year to see their full impact on the US inflation rate and economy, and whether those effects on the inflation rate are “transitory” or, because they had become baked into consumers’ expectations, more lasting. (The impact on prices, of course, is permanent.)
Trump has reversed all those trends in a massively risky, destabilising and, to date, destructive bet.
The uncertainties around the longer-term effects of Trump’s key policies, particularly tariffs, argue against the Fed acting too aggressively. If it cuts rates too hard too early, it might further fuel an inflation rate that is already well above its targeted rate.
The Fed is data-dependent and so could be expected to cut rates in 25 basis point increments as it gains new insights into the economy, assuming it is more concerned about unemployment than inflation at each decision point.
Its own expectation, at the June meeting, showed that the median expectation of the Fed officials who vote on rate decisions was for two 25 basis point cuts this year. The market is now pricing in three.
The risk remains that both the unemployment and inflation rates rise in tandem, threatening stagflation (low growth with rising inflation) and forcing the Fed to make an invidious choice as to which it should prioritise.
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Should the data force it to respond to inflation via increased rates, the one certainty is that Trump would double down on his efforts to stack the Fed’s board and/or coerce its officials into acting against their own instincts and experience.
That could lead to even higher inflation, an increased risk of recession and the undermining of the market’s faith in the Fed’s ability to respond as it should. Regardless of what the Fed did, market interest rates, which are determined by investors, not the Fed or the administration, would spike.
In less than eight months after inheriting an economy which was performing solidly, with the unemployment rate at historic lows, the inflation rate slowly but steadily trending down and the beginnings of an investment binge because of Biden’s incentives, Trump has reversed all those trends in a massively risky, destabilising and, to date, destructive bet that his policies may eventually produce a revival of the US manufacturing sector.
