Don’t be spooked by economic jargon. Skip to the proverbial bottom line. Investors are becoming very nervous. How do we know that? Because seasoned investors are accepting lower yields on long term bonds (compared to short term bonds). As investors worry about the short term, they invest in longer-term investments to lock in the best available interest rates. This drives the price of those investments up. Because the interest rate is generally fixed, the yield goes down as the price of the bond rises. (For example, if the demand for a bond that paid 2.5% interest and sold for $100.00 on June 1st drove the price of that same bond to $125.00 by July 1st, that same 2.5% rate of interest would, of course, represent a lower yield. Well, today, and for several weeks, the yield on long-term (ten-year) bonds is lower than the yield on shorter-term three-month bonds. Why would any investor accept a lower yield on a long-term investment? Well, simply stated, because he or she believes there is trouble ahead in the relatively short term.
Well, often, when investors begin to worry, they may eschew stocks and rush to lock in higher, long-term rates by purchasing long-term bonds to ride out the anticipated storm. But about what kind of storm are investors worried? Inflation, which is the kind of storm many investors worry about the most (other than deflation) seems to be nowhere on the horizon.
And our Central Bank, the Fed, really seems to be spooked, with most analysts anticipating a rate cut in the next month. The fed usually cuts rates to stimulate a moribund economy, but the economy, by all measures, seems very strong. Unemployment is at record lows and manufacturing growth is at record post-war highs. So, what is spooking the bond market and the Fed?
To paraphrase James Carville from the Clinton era: It’s Trump’s Trade Wars, Stupid.
It seems pretty certain that the Fed is weighing the toll Trump’s trade war will exact from our economy. That’s something the President should have weighed as well. Oxford Economics estimates that hiking the tariff to 25% on some Chinese imports last month will cost our economy about $62 billion by next year. That’s just under $500 per household. And if President Trump goes ahead with his threat to impose a 25% tariff on all imports from China, that would raise the cost per family to about $800. Our economy would be about $200 billion smaller by 2020.
Then there’s the job market. What toll on US jobs will the current tariff take? Oxford research estimates that the current tariff could result in 200,000 fewer jobs. And if President Trump extends the tariff on all imports from China as he has threatened to do, about 360,000 fewer jobs would be created in the United States.
And President Trump wielded his new tariff stick to prod Mexico to stop the flow of immigrants through that country. Trump no doubt will be emboldened to use his tariff club elsewhere when we have a dispute with another trading partner. The direct costs of these tariffs, both real and threatened are pretty easy to measure. The indirect costs, not so easy. JP Morgan Bank is pushing for two rate cuts before the end of the year because their analysts believe the toll is real and growing that Trump’s tariffs are taking on consumer and business confidence.
President Trump is running the country as he has run his businesses, by the seat of his pants. He takes counsel from no one. He has a history of closing various businesses and leaving untold employees, suppliers, and contractors holding a bag full of accounts receivable. We’ll face yet another need to raise the national debt ceiling in 90 days because we’re now running, for the first time in our history, a trillion-dollar budget deficit. A trillion dollars. Imagine that!
This all adds up to an incredibly ill-timed decision to go to war— a trade war with, well, just about everybody. History will determine whether President Trump is a skilled and thoughtful negotiator or a bull in a china closet. History’s verdict will take time. The Fed’s contemplation of a cut in interest rates and the ever-extending inverted yield curve suggests, however, that the china is rattling ominously.