Dust Off The Money Printer

Over the last few weeks, the trade war between the US and China has intensified with the U.S. economy starting to show signs of weakness.

Within a week of the announcement, President Trump was forced to issue a 90 day pause on tariffs as the 10 Year Treasury spiked back above 4% in a straight line. It has been clear that global capital has moved out of US assets indiscriminately. 

This puts the American Economy in a difficult position. 

With the 10 year staying sticky at 4%, President Trump’s plan to stimulate the economy and manage the US debt through lower rates is in trouble. Currently, the US may be forced to re-issue roughly $9 trillion of debt at 4% rates this year. To make matters worse, GDP growth is expected to slow due to tariffs. The combination of slowing economic growth and higher borrowing costs create a potential debt spiral for the US. Tax revenue could crater due to an economic contraction forcing the US to borrow progressively larger deficits to pay for government programs AND the interest on the debt. 

At this point, the economic future in the United States is once again in the hands of the Federal Reserve and Jerome Powell. President Trump is clearly aware of this and has come after Powell in recent days to lower interest rates, even threatening firing Powell, although this threat has since been walked back.

It was clear that the threat of firing Powell created more selling pressure in the markets as US investor confidence further deteriorated as evidenced in Monday's sell off.

Regardless if you agree with the method, there is an argument to be made that the Fed needs to step in to bolster the US economy. Clearly keeping borrowing costs low is crucial to managing the Federal debt, and by extension, US economic growth. The interest rates the Fed could lower do not affect the 10 Year Treasury Rate. The nightmare scenario is for the Fed to cut interest rates only for the bond market to continue to sell off. 

Although certainly not ideal, the Fed could step in and start to buy US Treasuries in order to artificially keep demand high and lower yields. The Fed has offloaded roughly $2 trillion from its balance sheet in recent years from the Covid highs so there is no reason the Fed could not go back to the Covid levels of Treasury holdings. This would certainly cause an uptick in inflation again as quantitative easing is the Fed’s way of printing money. With an increase in inflation, special attention needs to be paid to the already stretched consumer. 

Apart from comments from Chipotle on future spending, Q1 earnings have not shown signs of any serious economic distress with 60% of companies beating revenue forecasts, in line with past performances. The same can be said of the labor market as it stays stuck around 4%. Currently the market seems optimistic that there is a rebound especially if a resolution to tariffs is shared shortly as has recently been teased by the administration. However, looking deeper, the consumer is getting further and further behind. 

Auto delinquencies and student loans have been in the news lately as more and more borrowers are becoming delinquent on both. Student loans are specifically an issue as collections such as wage garnishment have resumed. Since Covid, these loans have been paused and not reported to the credit bureaus giving the impression that consumer credit was doing better than reality. Many of those delinquent on loans are those over 65 on fixed income. However, consumers can usually keep spending as long as they have a job, although that may change. 

The full effect of tariffs and Federal layoffs have not fully been felt throughout the labor market or the economy. The Government is still in the process of cutting roughly 200,000 jobs with another 75,000 that have taken buyouts with payments ending in September. With the economy slowing, these individuals may have a hard time finding work as tariff uncertainty causes companies to second guess hiring decisions. With the economy so dependent on consumer spending, a softening labor market would certainly spell disaster for the economy and stock market. 

The Federal Reserve once again has an impossible task.

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