By Vivien Lou Chen
“It is about an election that can fundamentally change the inflation picture for the next three to four years. And parts of the market are already concerned about this outlook,” says an inflation trader.
As many investors and traders remain uncertain about the prospects for cooling US inflation when Thursday’s consumer price index for June is released, Wall Street is pointing to the potential inflationary impacts of a second presidency under Republican Donald Trump. What’s emerging ahead of the release of the CPI report in a few days are two conflicting notions about where U.S. inflation is likely to go in the coming months and years — complicating the Federal Reserve’s analysis of the most appropriate path for interest rates, which remain at the level of 23. – Annual rates from 5.25% to 5.5%. All three major U.S. stock indexes DJIA SPX COMP were higher as of Tuesday afternoon, despite a decline in U.S. government debt that pushed up Treasury yields modestly. One view is that inflation will probably continue to moderate as US growth slows – giving the Federal Reserve the ability to cut interest rates as early as September. Economists expect the annual headline CPI inflation rate to fall to 3.1% in June from 3.3% in May, and inflation traders predict the rate will continue to fall toward 2% through May 2025. The other line of thinking is that inflation could rear its head again if Trump is elected to the White House because of his proposals on trade and immigration. Parts of the financial market expressed concern about Trump 2.0 with a two-day spike in Treasury yields on June 28 and July 1, with four months to go before Americans cast their ballots. “For good reason, traders like to link Trump’s policy agenda to inflation,” said Thierry Wizman, a New York-based global FX strategist and rates strategist at financial services group Macquarie. “They see that policy rates are higher than otherwise under Trump 2.0.” Trump leads President Joe Biden in polls nearly two weeks after their June 27 televised debate, focusing on the Republican opponent’s proposals for 10% tariffs on all imports and minimum 60% tariffs on Chinese goods. To be fair, Biden has also taken the brunt of the blame for the run of US inflation that started in 2021 and peaked in 2022, after his Covid relief plan led to an additional $1.9 trillion in spending. federal. Last week. Jan Hatzius, chief economist at Goldman Sachs ( GS ), said in a presentation at the European Central Bank’s annual conference in Portugal that Trump’s 10% tariff proposal could prompt reciprocal action from other countries. Considering the trade war that could unfold, Hatzius estimated that it could end up lifting US inflation by 1.1 percentage points and lead to five additional quarterly rate hikes by the Fed.
Separately last week, Deutsche Bank (DB) strategist Steven Zeng noted the potential impact of Trump’s immigration policy agenda on US interest rates. In the short term, higher immigration flows “have acted as a positive supply shock and contributed to the Fed’s ability to cut rates,” Zeng said. “Consequently, a reversal of these flows could result in higher wage inflation and a more hawkish stance by the Fed.” After Fed Chairman Jerome Powell’s first day of congressional testimony on Tuesday, Fed funds futures traders were pricing in a 70% chance of a quarter-point rate cut by September. Despite market expectations for a September rate cut by Fed officials, “I don’t see them cutting at all in 2024,” said inflation trader Gang Hu of WinShore Capital Partners in New York. Hu added that although investors are focused on the June CPI report on Thursday and Powell has reiterated the need for more signs of cooling inflation, the outcome of the Nov. 5 presidential election “could drastically change everything, so the Fed must tread carefully.” “Right now, it’s all about Trump. That’s the main topic, and the Fed can’t completely ignore the possible outcome of the election,” Hu said by phone. “This is a choice that could fundamentally change the inflation picture for the next three to four years. And parts of the market are already worrying about that picture.” The Fed’s job is to control inflation, so policymakers will likely have to consider the potential impact of Trump’s tariff proposals as well as his call for immigration reform. Immigrant workers have been seen as helping to boost the US labor market by taking jobs in areas where jobs have been hard to find. Meanwhile, Trump has proposed deporting millions of undocumented workers. On Tuesday, Powell dodged a line of questioning from a lawmaker that focused on Trump’s tariff plans. Then, when asked about inflation in the 1970s, the Fed chairman noted that “inflation kept coming back” because officials had not done the job of fully reducing price gains. Powell also said that the current era of inflation has been characterized by supply shocks and demand shocks stemming from the reopening of the US economy after the start of the Covid-19 pandemic.
“The Fed is absolutely not going to go anywhere near Trump’s policies by talking about them,” said economist Derek Tang of Monetary Policy Analytics in Washington. “Instead, it will try to walk the lines of saying the forecasts are uncertain coming out of Covid and those [policymakers] will use it as cover to whitewash any risk associated with Trump” ahead of the Nov. 5 election. “Politics clearly matters to economic forecasts in 2025 and 2026, but the Fed will pretend it doesn’t, so it’s gray area that they’re operating in,” Tang said by phone Tuesday. “The issue is, ‘Should they lower rates if the spot data says yes, but the forecast says no, and the forecast is a judgment of who’s going to win the election ?’ My guess is that policymakers will start to ease by September or December, and if they have to change course on the fly, they will” — which could become even more problematic by confusing investors.
-Vivien Lou Chen
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07-09-24 1414 ET
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