The Federal Reserve:
The Federal Reserve concluded its July meeting and to the surprise of no one, left interest rates unchanged. I think it was the right move. The economy seems to be doing well-enough and inflation remains above the 2% target (which I continue to insist is 2% too high). DKI has been outspoken and out-of-consensus in saying the Trump tariffs wouldn’t lead to disaster, but I do think the insistence of some that it will take a few more months for tariffs to work their way through the complicated supply chain and we could see higher inflation then is a reasonable concern. Powell continues to provide a measured presence talking about the good and bad of the economy always highlighting uncertainty. The big news is that for the first time in decades, the normally unanimous Fed had two Governors voting against the no change in policy decision. Whether they think it’s time to lower rates or whether they’re trying to impress the President with their accommodating stance and eager to replace an outgoing Chairman Powell is unknown.
My position on rate cuts is unchanged. They would have no good effect. Last September, when the Fed cut in a futile attempt to lower borrowing rates, the yield on the 10-year Treasury rose as the market priced in expected higher future inflation. As long as Congress keeps overspending, we’ll have further currency debasement which we all experience as inflation. Many people believe the Fed controls interest rates. The Fed only controls the overnight rate, and the bond market sets the rate on the rest of the yield curve. As I’ve written before, President Trump is wrong to insist on a lower overnight rate as I don’t think it will help his cause. Chairman Powell has been wrong on inflation for years as he kept the fed funds rate far too low for far too long. He was very late in hiking and early in easing.
I’ve been reading increasing criticism that people think President Trump has politicized the Federal Reserve. I think that’s simply partisan whining. Despite their official non-political mandate, the Fed has always been a political institution. They made FDRs massive New Deal spending possible. President Johnson famously slammed Chairman Arthur Burns into a wall strongarming him into lowering rates. And as I wrote last fall, Powell himself made the Fed look like political actors by cutting just ahead of the November election making the Fed appear to be favoring Vice President Harris. I’d like to see President Trump stop publicly pressuring Powell to cut rates. It’s unseemly and counter-productive. However, the idea that this is the moment that made the Fed a political actor makes me think of the famous line, “I’m shocked to find that gambling is going on in here.”
GDP:
Second quarter GDP growth of 3.0% crushed expectations of 1.5% – 2.4% (depending on your source). While that makes for good headlines, the number was meaningless. 1Q GDP was negative due to inventory stocking ahead of expected tariffs. That was reversed in 2Q as retailers and manufacturers under-ordered. (Imports subtract from GDP.) Results for both quarters were largely a result of tariff-related noise. In addition, government spending, even if wasteful, adds to GDP. So, Congressional overspending and waste makes GDP growth look much better than that experienced by the real productive private economy. The one thing that I think is a real positive here is this White House is going to great lengths to reduce job-killing over-regulation. Anything that unlocks the productivity of Americans and gets them out of regulatory hell is a positive for all of us.
Tariffs:
When President Trump announced his “Liberation Day” tariffs, fiat economists lost their minds. They told us he was going to destroy the economy and cause massive inflation. That hasn’t happened. Last April, I wrote a piece titled, “Tariffs – What if Everyone is Wrong” where I explained why I thought tariffs wouldn’t necessarily lead to a disaster. Increasing domestic supply would offset inflation and people were underestimating the probability that negotiations would lead to lower all-around tariffs. Finally, whether you like tariffs or not, our 40-year misadventure in selling off our manufacturing capacity has hit the point of unsustainable. Too many people are out of work, and our ability to make too many important products is a national security issue. Check out the linked piece if you want to read the full analysis. It’s not paywalled.
I’m in Europe right now and have run into a couple of people annoyed at how the President’s tariffs were potentially bad for the EU economy. When questioned, it was clear they had no idea of the trade barriers the EU (and other countries like Japan) have had against American products. I had something delivered to Portugal last month where I had to pay a 33% tariff to retrieve my package. That’s punitive and far above the 15% the EU and the US just agreed on going forward. I’m finding that many of the people claiming tariffs would wreck the economy (including the central bankers at Sintra, Portugal earlier this summer) come from countries with high tariffs themselves. It’s clear they like the tariffs that protect THEIR industries and dislike the ones that protect US industries.
Two weeks ago, I praised DKI’s young interns for writing that President Trump was monetizing access to the US’ huge consumer market. It’s clear that President Trump’s negotiations with the EU were a testament to that approach. The WSJ had a great article on these negotiations where it was clear that European leaders thought they’d be able to manage their way through and try to get tariffs down to zero. Once they saw the kinds of deals the President struck, they realized that wasn’t an option and shifted to trying to “contain the damage”. The article noted that “Tariffs of 15% are ‘certainly a challenge for some,’ European Commission President Ursula von der Leyen said. ‘But we should not forget it keeps [the EU’s] access to the American market.’”
Earlier this week, there were reports that President Trump stopped a border skirmish/war between Thailand and Cambodia by threatening to exclude anyone engaging in violence from the US market. Fighting stopped that day. Many don’t like his methods and more don’t like his style, but he’s getting results. In our weekly Five Things piece, we regularly note the additions to the trillions of dollars of purchase orders the President has brought back from other countries and wondered why other Presidents and politicians don’t act as advocates for US companies.
I think Stephen Innes, who writes the excellent Dark Side of the Boom blog, phrased it best:
Still, the dollar refuses to flinch. In fact, it’s rallying—and not just against the euro. This week’s sharp drop in EUR/USD wasn’t isolated; the greenback surged broadly, suggesting the market may finally be shaking off the trade war risk premium it priced in back in April. With 60% of U.S. trade now covered by tariff détente (Japan, EU, UK), Washington’s economic bazooka looks more like a scalpel—controlled damage, minimal blowback, and that is providing a tailwind for the dollar again.
The logic? Tariffs have become a fiscal boon, not a bust. They’re juicing Treasury receipts without detonating consumption—yet. Inflation is lingering, but that just buys Powell more time on the sidelines. Rate cut bets are being repriced accordingly, and yield differentials are starting to matter again. The days of the dollar dancing to Trump’s Truth Social feed may be numbered.
The naysayers have a point that tariff inflation may still come and that our trading partners may not live up to the announced terms. For now, DKI’s April piece suggesting it wouldn’t be bad and Innes’ piece describing tariffs as a scalpel with minimal blowback are looking correct. Don’t worry if you disagree. The fun in macro is how quickly things turn and in international macro, things always turn.
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