By Jamie McGeever
ORLANDO, Florida (Reuters) -TRADING DAY
Making sense of the forces driving global markets
By Jamie McGeever, Markets Columnist
A dramatic day on Wednesday ended with Wall Street in the green and the dollar and short-dated Treasury yields lower, although off their earlier extremes, after President Donald Trump denied reports he will soon fire Fed Chair Jerome Powell.
More on that below. In my column today I look at Trump’s call for 300 basis points of Fed rate cuts and, although it is wishful thinking, why it shines a light on whether Fed policy is too tight, too loose, or maybe just about right.
If you have more time to read, here are a few articles I recommend to help you make sense of what happened in markets today.
1. Popping the dollar’s ‘anti-bubble?’: Mike Dolan 2. Central banks ramp up buying at euro zone bond sales 3. EU trade chief heads to Washington in search of tariffssolution 4. Beneath China’s resilient economy, a life of pay cutsand side hustles 5. Markets call Trump’s bluff on Russian oil sanctions inincreasingly risky game: Bousso
Today’s Key Market Moves
* U.S. Treasury yields fall across the curve, mostly at theshort end – 2-year yield falls 7 bps. * The 2s/10s U.S. curve steepens through 60 bps, its highestin nearly two months. It steepens for a fourth day, its longeststreak this year. * Wall Street rises, led by small caps – the Russell 2000gains 1%, clawing back half of the previous day’s losses. * The dollar index snaps a six-day winning streak and fallsaround 0.3%. * Gold rises 0.8% to $3,350/oz.
Trump-Powell drama sizzles, dollar fizzles
At around midday in the U.S. session on Wednesday, it looked like six months of verbal attacks on Fed Chair Jerome Powell from President Donald Trump for not cutting interest rates were about to reach boiling point – according to Bloomberg News, Powell would soon be fired.
The market reaction was what you might expect – the dollar, stocks, and short-dated Treasury yields fell, and the yield curve steepened. The most notable moves were in the dollar and two-year yield.
But Trump swiftly denied the report, insisting that although he had discussed ousting Powell with lawmakers, it was “highly unlikely” he would fire him. Markets recovered their poise, especially stocks, although the rebound in short-dated yields and the dollar was less pronounced.
Trump firing Powell would be a monumental event as no president has ever formally dismissed a Fed Chair. But it would come as little surprise. Trump’s desire for lower interest rates is ferocious, and he regularly berates Powell for not cutting them. Political interference in monetary policymaking? Yes, but Trump crossed that Rubicon some time ago.
Rates traders still expect no change from the Fed on rates later this month and a quarter point cut by October. They added around 10 bps of expected easing into next year’s forecasts.
Even at the depths of the selloff on Wednesday Wall Street’s main indices were never down more than 1%, perhaps reflecting investors’ skepticism that Trump really will pull the trigger. But it’s noteworthy given that the S&P 500 and Nasdaq had clocked new highs the day before – there’s scope for a deep correction if investors want one.
The latest twist in the Trump-Powell saga dominated the U.S. session and will likely be the main driver of global markets again on Thursday. But investors have other signposts to guide them, including corporate earnings, tariffs and economic data.
On Wednesday, three of America’s biggest banks reported results – Bank of America, Morgan Stanley and Goldman Sachs. On Thursday the spotlight turns to Netflix, and before that in Asia, Taiwan’s TSMC, the world’s main producer of advanced AI chips.
Trump boxes in Fed with extreme rate cut calls
While almost no one thinks Donald Trump’s verbal attacks on Federal Reserve Chair Jerome Powell are a positive development, they have electrified the debate about whether the U.S. president is right that interest rates are too high.
Presidential tirades aside, there is a strong case to be made that the fed funds rate should be lower than its current 4.25-4.50% target range. The labor market is beginning to show signs of cracking, ‘hard’ economic data is softening, and a tariff-led slowdown may be in the offing.
On the other hand, economic growth is clocking in at an annualized pace of around 2.5% and not expected to dip much below 2% next year, unemployment is still historically low, the stock market is at a record peak, and other financial assets like bitcoin have also never been higher. And, crucially, core inflation is still almost a percentage point above the Fed’s 2% target, suggesting that we may be starting to see the inflationary impact of tariffs.
By those measures, policy may be too loose, not too tight.
Indeed, Jason Thomas, head of global research and investment strategy at Carlyle, reckons financial conditions are “unusually accommodative”, and argues that had the Fed not said in December that policy was ‘restrictive’, there would be no need to explain why it hadn’t cut rates six months later.
The president clearly does not agree. Trump is clamoring for borrowing costs to be slashed by 300 basis points. That would take the policy rate closer to 1%, a level usually associated with severe financial market stress, strong disinflationary pressures or a deep economic funk. Or all three.
R-STAR GAZING
One would be hard-pressed to find many experts who would agree with Trump’s call, even those who fall on the dovish side.
But then where should rates be?
Policymakers typically use forward-looking models and frameworks to inform their decisions. The most famous of these, so-called ‘R-Star’, comes in for a lot of criticism, as it is theoretical, referring to the inflation-adjusted long-term neutral interest rate that neither accelerates nor slows growth when inflation is at target. This may be a fuzzy concept, but officials look at it, so investors cannot dismiss it completely.
There are two benchmark ‘R-Star’ models, both partly created by New York Fed President John Williams. One currently puts this rate at around 0.80% and the other around 1.35%. If inflation were at the Fed’s target 2%, then these models would put the nominal fed funds rate at around 2.80% or 3.35%, respectively. Fed policymakers split the difference in their latest median projections, putting the long-term nominal Fed funds rate right at 3.00%.
If these estimates are anywhere close to accurate, the nominal policy target range of 4.25-4.50% now appears to be restrictive, so the path ahead is lower.
Rates traders and investors seem to agree. While the latest CPI report has caused jitters at the long end of the yield curve, rates markets are still pricing in more than 100 basis points of easing over the next 18 months.
But this has helped fuel the asset price rally, which, ironically, strengthens the argument that policy may be closer to neutral than models suggest.
WISHFUL THINKING
Powell may have backed the Fed into a corner by maintaining that policy is still restrictive, albeit “modestly” so.
These claims signal the Fed will lower rates, but it has not done so, as it is waiting to see if Trump’s protectionist trade agenda unleashes inflation. Moreover, it also does not want to appear to be responding to political pressure to cut rates.
“Some will say this collision was unavoidable. But the Fed would find itself in a far more defensible position had it embraced a posture of neutrality, pledging to cut or hike as warranted by future developments (including policy shifts),” Carlyle’s Thomas wrote on Tuesday.
In short, the Fed is in a bit of a bind, and Trump’s attacks will only make it worse. His call for 300 basis points of rate cuts may end up being similar to his ‘reciprocal tariff’ gambit: aim extremely high, settle for something less, and claim victory.
The problem, of course, is that monetary policy is not supposed to be a negotiation.
What could move markets tomorrow?
* Australia unemployment (June) * Taiwan’s TSMC Q2 earnings * Japan trade (June) * UK unemployment, earnings (June) * U.S. weekly jobless claims * U.S. Philly Fed business index (July) * U.S. retail sales (June) * U.S. Q2 earnings, including Netflix * U.S. Fed officials scheduled to speak: San Francisco FedPresident Mary Daly, Governors Lisa Cook, Andriana Kugler andChristopher Waller
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Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias.
(By Jamie McGeever)
