In a triplet of tweets Wednesday morning, US President Donald Trump defended his trade war escalation and demanded that the Fed cut interest rates to reverse the negative impact on the stock market and economy. The trouble is that the Fed’s influence on the stock market is fading, while the impact of China risk has jumped. The president is likely to be disappointed whether or not the Fed follows his advice. Goldman Sachs economists earlier this week predicted a third interest rate cut in addition to last month’s 25 basis point cut and another widely expected by the market. Hope that the Fed would come to the rescue motivated Tuesday’s US market rally, but the market gave up those gains in the Wednesday session.
Tweeted the president:
“Our problem is not China – We are stronger than ever…Our problem is a Federal Reserve that is too proud to admit their mistake of acting too fast and tightening too much (and that I was right!). They must Cut Rates bigger and faster, and stop their ridiculous quantitative tightening. Yield curve is at too wide a margin, and no inflation! Incompetence is a terrible thing to watch, especially when things could be taken care of sooo easily. We will WIN anyway, but it would be much easier if the Fed understood, which they don’t, that we are competing against other countries, all of whom want to do well at our expense!”
The Fed’s December quarter-point rate increase, to be sure, tumbled the stock market at the end of 2018, and the Fed’s moonwalk back to dovishness motivated the market’s quick recovery. A simple measure of the Fed’s influence on the stock market, though, shows that the impact of rate policy is diminishing.
The chart below shows the rolling correlation of daily returns to the S&P 500 vs. daily returns to the 12th federal funds futures contract, which shows where investors think the Fed’s overnight rate will stand a year from now. It also shows the rolling correlation of returns to the S&P with a gauge of China risk, namely returns to options on the RMB-US dollar exchange rate.