Traders don’t concern themselves with Trump tweets anymore

What the Business Media is Reporting

After the November 2016 presidential election, the new rallying cry was the “Trump Effect” as supporters of the newly minted president sold the narrative that Mr. Trump’s administration would be good for the financial markets and the economy as a whole.  Mr. Trump’s Twitter pronouncements on NAFTA, manufacturing, and trade with China seemed to embolden markets, but as noted in this article in The Financial Times, Mr. Trump’s tweets no longer get the attention of traders.

What is getting the attention of traders?  According to Bloomberg.com, among trader concerns are the dovish comments of central banks.  The Federal Reserve has been signaling that it may take a break from rate hikes.  Low yielding debt, according to Bloomberg analysis, has been scaring investors, however, increases in yields scare asset managers given the threat to values that result from the inverse relationship between yields and asset prices.

Bloomberg estimates that, under the rule of duration,  a full percentage point increase in yields could result in a seven percent erosion in market value.  The bond markets may be looking at a $2 trillion loss.

Government Moves Traders Should be Concerned About

This is budget season as committees in Congress review agency requests.  According to the Congressional Budget Office, the U.S. government is facing a Fiscal Year 2019 budget deficit of $897 billion.  Unless the government can close this gap with increased revenues or less spending, it will go into the debt markets, issuing bonds to help close the gap.

As the deficit widens, there will be an increase in supply of government bonds, a fall in bond prices, and an increase in interest rates.  Funds will be taken out of the private sector portion of the economy and move into government coffers.  In other words there will be less money available to invest in factories, plant, and other infrastructure necessary for economic growth.

While the Federal Reserve gets a lot of play in the media, traders should not allow the glitz that the media paints on the central bank to distract them from the budget activities of Congress.  Congress, as keeper of the purse strings, has a key role in managing the economy.  Its processes, while a lot more mundane than a presidential tweet, are important to monitor.

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In this theater, the media is also a combatant

The Board of Governors of the Federal Reserve is meeting over the next two days to discuss whether or not to raise the federal funds rate.  The federal funds rate is an interest rate that banks assess each other when borrowing money overnight from each other.  The Federal Reserve, America’s central bank, drove the rate to near zero in attempt to boost the economy after the financial markets crashed. 

Lenders became wary of the collateral other financial firms were carrying in their portfolios, typically asset and mortgage-backed securities that were declining in value due to the inability of commercial and residential borrowers to keep up with interest and principal payments. By buying these securities from financial firms on poor footing and giving them cash, the Federal Reserve hoped to prime the lending pump and provide financial institutions with the confidence to go out and lend again.

 Mr. Trump has been taking issue with rate hikes, making the argument that the timing is horrible for the financial markets and the economy overall.  To some extent, he has a point; increasing rates could eventually lead to a devaluation of assets sensitive to rate increases, and where these assets are used as collateral for loans, being awarded a loan becomes a lot tougher if a bank does not think collateral is strong enough.

From a political warfare perspective, the media has time to time pointed out Mr. Trump’s apparent lack of respect for the independence of the Federal Reserve, specifically taking issue with Mr. Trump questioning Federal Reserve Board chairman Jerome Powell’s rationale for rate hikes.

But by commenting on the direction of rate hikes, is Mr. Trump really attacking the independence of the Federal Reserve? My answer is no.  

Under the Full Employment Act, the Congress, the Federal Reserve, and the President are to coordinate their activities in order to bring about the effective control of inflation, genuine full employment, production, balanced growth, and a balanced federal budget. The chairman of the Federal Reserve is to connect his monetary policy to the numerical goals established by the president in his economic report. That the President was transparent and vocal in pointing out what he considers the Federal Reserve’s pursuit of a policy that seems out of sync with his may be brash, but is not out of step with the coordination the law requires and even the transparency that many citizens in the United States allegedly prefer.

How well has the Trump administration, the Board of Governors, and the Congress coordinated on the economy is subject to another discussion, but the point here is that the media and other critics have failed to give the public a full picture of what is entailed in economic management and this lack of full disclosure on the part of media only adds to Mr. trump’s assertion of fake news and unfair targeting of him by the press.

The other takeaway, of course, is going and investigating other sources of information on the management of the American political economy.  In political warfare, you need to know where all the bullets are being fired from.  In this theater, the media is a combatant.   

Trump and the Federal Reserve: Governing with transparent purpose

Listening to the rhetoric of President Donald Trump over the past 19 months, if I were to summarize the role of government, it is to defend national borders, sustain an environment that creates jobs, and be impactful in driving up stock market values.  Mr. Trump has effectively drowned out the Republican congressional leadership to the point where I don’t care what Senate Majority Leader Mitch McConnell or Speaker of the House Paul Ryan’s views on what the government’s role is supposed to be.

Under my interpretation of public administration, the buck, when it comes to governing, begins and ends with who is in the White House.  It is the Executive who enforces the law and interprets the law every day given a particular problem.  An argument can be made that during the run-up to the 2020 presidential election, the views of Mr. Trump’s challengers will take on some importance as voters compare the record of Mr. Trump with the promises of his Democratic challenger, but Americans have a way to go before the Democrats settle down on a few contenders and beginning pushing their messages before the electorate.  All we have right now are the whispered names of Andrew Cuomo, Elizabeth Warren, Joe Biden, and, yes, Hillary Clinton.

I suspect that none of the above named Democrats will be serious contenders in the spring of 2020 anyway.  Listening to the roll call of potential presidential candidates is like believing that the baseball team leading their division eight weeks into the season will be in the World Series much less holding the trophy.

In my lifetime, Mr. Trump has been the most transparent of presidents when it comes to the factions that he promotes.  Mr. Trump has been consistent and clear with his America’s economy first message. He took Mr. Trudeau out to the woodshed during the renegotiations of the North American Free Trade Agreement.  He kept his word on pulling the United States out of the Paris accords on climate change and the Trans Pacific Partnership Agreement.  He will not enforce the mandate that taxpayers are required to purchase health insurance, facing penalties if they don’t.  These initiatives are driven by a philosophy of American economic nationalism with the hopes of creating incentives for American businesses to repatriate jobs and cash to America’s shores.

He’s recently been transparent about the most important engine in the American economy: the Federal Reserve.  Mr. Trump disapproves of the Federal Reserve’s increase in the target for its federal funds rate, even though the Federal Reserve’s independence gives the central bank the okay to thumb their noses at the President.  The federal funds rate is the interest rate at which the Federal Reserve’s member banks may lend each other money overnight.  Changes in the fed funds rate seep into the overall economy in the form of mortgage rates, credit card rates, and interest rates on bonds.  Higher rates raise the costs of borrowing making it tougher for businesses to invest in growth including hiring more labor.

Higher rates mean that the economy’s “labor to tax conversion mechanism” becomes less efficient.  The labor to tax conversion mechanism is that layer of the economy where companies convert human resources into tax dollars by adding labor to payroll and collect and transmit income, payroll, and social security taxes to the Treasury.  Tax dollars are collected by the U.S. Treasury and either deposited for future spending on public programs or to service the debt.

But as I alluded to before, companies will feel constrained by interest hikes as they see revenues and profits reduced by higher costs for doing business. This may mean, depending on the business, a move toward automation in order to reduce labor costs.  Taking labor off of payroll means removing a head that could be taxed.  Will government have to apply some type of alternative tax applicable to an artificial intelligence that replaces a human intelligence on a factory line?

Going back to transparency, neither Mr. Trump or any leading Democrats have clearly demonstrated an ability to describe to the American public how their current economic environment works.  Neither begin any of their discussions on the economy with a discussion on capital or describe how the central bank is still the only game in town and the relationship to and importance of the central bank to all Americans. Mr. Trump has come the closest which means at this time he is the only elected official that gets it.

 

On Powell, Trump, and low rates

Donald Trump has shown no shyness when it comes to lamenting his regrets. When those regrets take the form of personnel, he fires them.  Over the past 48 hours, Mr. Trump has been expressing his frustration with current Federal Reserve chairman Jerome Powell.  Mr. Powell has been on a rate raising course since his appointment earlier this year and Mr. Trump believes that, setting aside what he perceives as Mr. Powell’s enjoyment, that this is not the time, given the advances in the economy and the stock market, for rate increases that may dampen or slow down the Trump Effect.

The textbook logic behind the Federal Reserve’s rate increases is to control the growth in asset values. Assets serve as collateral for borrowing and lending money.  If a potential lender sees an opportunity to lend $1,000,000 at 5% and has a portfolio of assets valued at $1.5 million, it will use its $1.5 million in assets to borrow the $1 million at say 2% and lend those funds out at 5%, and with all things equal, bring home a net return of 3%.

If the Federal Reserve believes that discipline is in order, it will raise the rates at which  banks borrow from each other overnight. It may also raise the rates on the funds that banks leave on deposit with the Federal Reserve. Both moves are designed to keep potential loanable funds out of the system, making money scarce and more expensive to find.  Also, higher rates, because of their inverse relationship with asset prices, result in asset values falling. This means that banks, businesses, and individuals will receive less funding because the collateral they have has lessened in value.

Increases in rates threaten wealth growth and consumption.  With the advent of modern central banking, nation-states have transformed into payment systems where taxes are collected, interest payments made to bond holders, and budgets used by politicians to bribe voters are financed.

It is the role of government to ensure the political-financial payment system operates at maximum.  Rates should stay low to encourage borrowing and investing.  Deficits should be eliminated resulting in less pressure to increase interest rates in order to attract purchasers of Treasury notes and lower rates for borrowers in the private sector.

Mr. Trump, unlike most of his critics and I dare say most central bankers, has a better understanding of this reality.