Can Central Banks Balance Tariffs and Slower Economic Growth with Stimulus?

The markets seem to think so.

Last Friday the big news was far lower job growth in conjunction with cooling wage gains. This is traditionally bad news for the markets as it suggests broader economic weakness. However, to Fed watchers this is good news as it adds support for the belief the Fed will soon cut rates to stimulate the economy.

So bad news is good news, and the equity markets rallied.

The bad news of slower economic growth is nothing new. The escalation of trade war rhetoric is weighing on growth and investor sentiment. Tariffs are a tax on consumers, and the New York Federal Reserve recently argued that the cost of current tariffs have essentially wiped out the recent tax cuts for middle income consumers. Additionally, the uncertainty surrounding when and how tariffs will be implemented can freeze corporate spending decisions. Consumer spending may be the largest part of the economy, but corporate spending is more volatile and can quickly move the economic needle.

A similar bad news is good news story is also being played out in Europe and China. Last week Mario Draghi said the European Central Bank was ready to “use all the instruments that are in the toolbox” if the export-driven manufacturing sector of the economy continues to be weakened by tariffs. Europe is a large exporter to China, so if China is impacted by tariffs so is Europe. Also last week, China’s central bank governor said there’s “tremendous” room to adjust monetary policy if the trade war deepens, and he also signaled China could allow its currency to depreciate.

So, is bad news really good news?

Cheap money is not the cure for all economic ills, but it is the biggest hammer in a central bank’s tool kit. As such, we continue to view the Fed as the driver of not just bond market performance in 2019, but risk asset performance as well.

Source: Bloomberg, the Financial Times