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Fed says it's trade, not rates, that's undermining the US economy

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Mr Powell and the Fed have been accused by President Trump of having a "horrendous lack of vision".

Washington

PRESIDENT Donald Trump has a pithy message to Americans worried about the economy: It's the Fed, Fed, Fed.

The Federal Reserve has a snappy retort: It's trade, trade, trade.

Central bank officials are loath to engage the president directly. But as they gathered last week in Wyoming, policymakers explained again and again how trade disputes are poisoning the global economy and making their job more difficult.

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"The fulcrum or centre of gravity of the US economic policy today is not monetary policy, it is trade uncertainty," Dallas Fed president Robert Kaplan said on Thursday as the Kansas City Fed's annual symposium in Jackson Hole kicked off.

He was followed by Patrick Harker, president of the Philadelphia Fed, who recounted what businesses in his district are telling him. "What we hear repeatedly from companies is the trade uncertainty. It is not the cost of capital," he said.

In other words, don't be fooled by Mr Trump into blaming the Fed for what's slowly curdling the world's largest economy, illustrated by the weakening of business investment and manufacturing output.

Mr Trump has elevated his criticism of the central bank to a shrill level in recent weeks. In a blunt tweet on Friday he wondered who was a bigger "enemy", Fed chair Jerome Powell or Chinese President Xi Jinping.

Asked later by a reporter at the White House whether he wants Mr Powell to resign, Mr Trump said: "Let me put it this way: If he did, I wouldn't stop him."

Earlier this month Mr Trump called the Fed "clueless", all part of his campaign to pressure officials into lowering interest rates more aggressively, to stimulate the US economy. Economic growth this year is still projected to hit about 2 per cent, but that's not fast enough for Mr Trump, and he's blamed the Fed. "Our economy is very strong, despite the horrendous lack of vision by Jay Powell and the Fed," he tweeted on Aug 19.

That sort of name-calling is surely annoying for Mr Powell and his colleagues. More practically, however, it is Mr Trump's extended and unpredictable trade wars that are making it difficult for the Fed to keep the economy on an even keel.

Mr Powell tiptoed into the trade issue more carefully than his colleagues in his prepared remarks to central bankers at Jackson Hole on Friday. He made clear it is not the Fed's job to set trade policy. But there was subtle pushback as well.

There are "no recent precedents to guide any policy response to the current situation", he said. "While monetary policy is a powerful tool that works to support consumer spending, business investment and public confidence, it cannot provide a settled rule book for international trade."

Indeed, Mr Trump's Friday tweets were a good illustration. While Mr Powell's speech, released at 10am New York time, might have encouraged investors by hinting strongly that an interest rate cut is coming in September, markets plunged after Mr Trump tweeted about an hour later, vowing retaliation against China in the latest escalation in the trade war. Yields on 10-year US treasuries fell to near 1.5 per cent.

Mr Powell's remark about "no recent precedents" is an expression of what economists call Knightian uncertainty. It's a concept named for American economist Frank Knight who distinguished unknowable outcomes from risks that are statistically quantifiable. For example, Fed officials can come up with estimates about how tariffs will affect import and export volumes and tie that into an outlook for growth, said Michael Gapen, chief US economist at Barclays in New York. It's harder, however, to know how tariffs impact business confidence, investment plans and hiring, he said.

"Powell understands more than most Fed presidents that you are going to have to think beyond the model right now," said Julia Coronado, the head of MacroPolicy Perspectives in New York. "Powell's answer is, 'Even if you don't know the impact of developments with certainty, you have to take action. It is a message of open-ended policy recalibration as needed.'"

For companies, uncertainty has also crept into uncharted territory. Mr Kaplan said the turning point came in May when Mr Trump, despite having struck a fresh trade deal with Canada and Mexico, threatened to impose new tariffs on Mexico unless it stemmed the flow of migrants to the US. That shook companies for two reasons. It meant even after a dispute settlement Mr Trump might still throw any deal out the window. Second, Mr Trump might pick a fight for any non-economic reason and use tariffs as a weapon. More broadly, it hardened the sense that White House trade policy was no longer linked to a predictable strategy.

"Since that point a lot of businesses I speak to have become more cautious on capex and on expansion plans," Mr Kaplan said in a CNBC interview, referring to capital expenditures. "Businesses now have internalised that trade uncertainty is going to be with us for some extended period of time, even if some of these bilateral trade issues get resolved." BLOOMBERG