Central bank policymakers on both sides of the Atlantic were a lot more worried about trade tensions at the beginning of August than they let on at the time. Those worries might be enough to interrupt the Federal Reserve's plans for raising rates beyond September. This aligns with the ECB's expectation that global growth will continue, but more slowly because of weakened trade momentum.
Pause After September Hike?
The minutes of the last Fed policy meeting, released Wednesday after a three-week moratorium, said—in language as clear as can be expected from central bankers—the impact of escalating trade disputes could prompt them to hit the pause button after next month's rate hike. “Some participants suggested that, in the event of a major escalation in trade disputes, the complex nature of trade issues, including the entire range of their effects on output and inflation, presented a challenge in determining the appropriate monetary policy response,” the minutes said.
In the plain English favored by Fed Chairman Jerome Powell, this means the Federal Open Market Committee might suspend its plan of regular quarter-point rate hikes. The dot-plot graph that accompanies every other FOMC meeting showed in June that a majority of policymakers expect four rate hikes this year, which would include one in December, as well as the virtually certain hike next month.
Now investors will be focusing on the dot-plot graph for the Fed's meeting September 25-26 to see if those expectations have changed. At the moment, traders are pricing in a 96% probability of higher rates in September and 67% chance for another hike in December, according to Investing.com’s Fed Rate Monitor Tool.
Protectionism Worries ECB as Well
The European Central Bank has more or less frozen its monetary policy tools for the time being, but the minutes of the ECB's late July meeting, released on Thursday, show concerns about trade as well. The members of the ECB governing council noted that the unexpected decline in yields on US and German government bonds could be attributed in part to uncertainty about the economy due to the trade disputes.
They also felt that trade tensions negatively impacted stock market valuations in some places, notably in China, where stocks have fallen 20% since their January peak. Mounting trade tensions also “weighed” on eurozone equity markets, they said. “They furthermore agreed that uncertainties related to global factors remained prominent, in particular with regard to the threat of protectionism and the risk of an escalation of trade tensions,” the ECB minutes said.
Both central banks are satisfied that inflation is close enough to targets to not be a concern. The ECB council expressed confidence about medium-term “convergence” of inflation with its 2% target, though it added that continued monetary stimulus was necessary to maintain the trend.
Fed policymakers spent some time debating the significance of a yield curve nearing inversion, when yields on short-term rates are higher than on long-term bonds. Historically, this has indicated the approach of recession.
But some of the FOMC participants argued that inferring causality from correlation leads to false conclusions. In line with the ECB observations, they felt low yields on long-term paper was due more to the strong worldwide demand for safe assets, as well as the central bank asset purchases themselves.
The two camps remain divided and the debate could become another reason for hesitation in the gradual tightening of rates in the US.
Minutes Help the Fed With Independence Controversy
The minutes were released just as policy makers from around the world were convening at Jackson Hole in Wyoming for the annual economic symposium there. Both Powell and ECB President Mario Draghi will speak and investors will be looking for any further signs of concern on the trade front.
The silver lining for Powell is the documented worries about trade concerns help the Fed in the tricky political situation in which it finds itself. President Donald Trump’s recent criticism of Fed rate hikes make it virtually impossible for the central bank to back down on the September increase, for fear of being perceived as bending to the president’s will. But after expressing its concerns about trade, the Fed will have more flexibility in leaving rates unchanged in December without appearing to be intimidated by Mr. Trump.