Week in Review
For the week the equity markets were lower by 2 percent as investors reacted to the news that President Trump intends to impose a 25-percent tariff on steel imports and a 10-percent tariff on aluminum imports fueling fear of protectionist economic policy. Interest rates were slightly lower due to the volatility in the stock market with the 10-year U.S. Treasury falling in yield from 2.89 percent to 2.86 percent.
Fed Chair Powell - Yellen 2.0
Jerome Powell made his public debut this week as the Chairman of the Federal Reserve, testifying in front of Congress for two days. During the first day of testimony the market interpreted his comments as more hawkish or, said differently, more inclined to increase short-term interest rates in order to tap the brakes on the economy. During the second day of testimony, his comments were considered more dovish in their interpretation. The key takeaway from this testimony is that Chairman Powell seems to view the economy in a very similar fashion to the Former Fed Chairperson Janet Yellen. This is good news for the markets in that the financial markets hate uncertainty more than anything. Fed Chairman Powell is not a newcomer to the Federal Reserve having served on the Board of Governors since 2012. He is different from the most recent Fed chairs in that he was formerly employed in private equity and is not a Ph.D. economist.
The Fed has done a good job of signaling what they intend to do with short-term interest rates during this economic cycle. One of the mechanisms the Fed has in their toolbox to control the economy is the movement in the Federal Funds Rate. The Fed Funds Rate is a short-term interest rate that banks use to lend each other money. By lowering the interest rate, it stimulates the economy. Conversely, by increasing the interest rate it slows the economy.
Since the financial crisis of 2008-2009, the Fed has increased interest rates five times to 1.5 percent at a very deliberate pace. Forecasts for this year are for three-to-four interest rate increases. The Fed can move slowly because inflation is under control at below-2 percent and the economy is not overheating. The Fed wants to normalize short-term interest rates, so they have the ability to lower interest rates if necessary in an effort to stimulate the economy during the next recession, whenever it should occur.
The announcement of tariffs on steel and aluminum this week was an unwelcome surprise to the markets. Tariffs, simply put, are a tax on imported goods meant to protect domestic industries and jobs. Economic history has shown that protectionism and trade wars are not good for the economy or markets. It is still early days relative to the steel and aluminum tariffs and the threat of tariffs may just be a negotiation strategy to get importers of steel and aluminum to refrain from unfair trade practices.
Takeaways for the Week
- Jerome Powell's comments this week to Congress suggests that he sees the economy and the pace of interest rate increases similarly to immediate past Chair Janet Yellen. Financial markets should respond positively to this continuity from the Fed
- Virtually all economists agree that protectionism is negative for the economy and the tariffs being discussed could just be a negotiation tactic, not a shift in policy