Given the lags in impacts, it was logical that the PBOC should be the first of the two central banks to move. On Tuesday, it unveiled a package of monetary policy support, including a 10-basis-point cut in its key short-term interest rate, a 50-basis-point reduction in the required reserve ratio for its banks, more credit available for consumption, aged care and the tech industries, and cheaper credit for mortgages.
Jerome Powell and the Fed are in wait-and-see mode. Credit: Bloomberg
In effect, it is making more liquidity and credit available within its financial system although, in the continuing absence of fiscal stimulus from Beijing, it is an open question whether there will be any demand for that credit from Chinese businesses and consumers that were in a defensive mode even before Trump’s assault on global trade.
The PBOC’s announcement might also have been designed to send a message to the Trump administration ahead of this weekend’s meeting of Chinese and US officials in Geneva: that China has levers to pull to blunt the effects of the trade war. The absence of fiscal stimulus could be interpreted as a sign that Beijing isn’t panicking – it has its “bazooka” in reserve.
The meeting between Bessent and China’s Vice Premier He Lifeng isn’t going to produce a trade truce. As Bessent told Fox News, they will be initial talks to “agree what we’re going to talk about”.
“My sense is that this will be about de-escalation, not about the big trade deal,” he said.
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Any actual trade deal between the US and China could take months, if not years, to thrash out, and it is unlikely that, during the remainder of Trump’s term, they will be reduced to anything close to the average of about 20 per cent rate they were before Trump began ratcheting them up this year. (The 20 per cent rate was a legacy of Trump’s first trade war in 2018-19 which Joe Biden retained.)
During his election campaign last year, Trump promised a 60 per cent duty on all imports from China, which is probably the US’ final position in any negotiation. Trump has said Americans will need to accept higher prices and reduced choices if his attempt to return manufacturing investment and employment to the US is to succeed.
Before April 2, the average US tariff on imports was only 2.5 per cent. The best outcome now appears likely to be a minimum average tariff on all imports to the US of at least 25 per cent, although with Trump dreaming up new tariffs and forms of tariffs – the “Hollywood” tariff on offshore film production, the first tariff mooted on services rather than goods, is the most recent example – it’s anyone’s guess where the final imposts will land or what their eventual impact on the US economy will be, other than that it won’t be positive.
That explains why the Fed is frozen in “wait and see” mode.
In its formal statement, the Fed said that uncertainty about the economic outlook had increased further and the risks of higher unemployment and higher inflation had risen.
Given the lags in impacts, it was logical that the PBOC should be the first of the two central banks to move.Credit: Bloomberg
Powell told a news conference that “it’s not really clear what it is that we should do” and that he could not yet say “which way this will shake out” in terms of being more worried about inflation or growth. The costs of waiting, he said, were still low.
The Fed couldn’t act pre-emptively to head off the inflationary impacts of the tariffs “because we actually don’t know what the right response to the data will be until we see the data”, he said.
“If the large increases in tariffs that have been announced are sustained, they’re likely to generate a rise in inflation, a slowdown in economic growth and an increase in unemployment,” Powell said.
“The effects on inflation could be short-lived, reflecting a one-time shift in the price level,” he added.
It was also possible, however, that the inflationary effects could be more persistent, he said.
Powell said it was premature to declare which side of the Fed’s dual mandate – inflation and employment – would be prioritised.
That’s the Fed’s dilemma. If the inflationary effects of Trump’s tariffs are transitory, it would cut rates to protect growth and employment.
The differences in stance don’t reflect calm in the US and panic in China, but the leads and lags within the trade wars that Trump launched.
The Fed is acutely aware, however, that when it declared the impact on inflation of the pandemic to be transitory and lowered rates further than, with hindsight, it should have, it unleashed a wave of inflation it is still battling to contain. It can’t afford to make the same mistake again.
The Fed prides itself on being data-driven. It will wait for the data, which means it will be reacting to the effects of the tariffs after they have already emerged, rather than trying to pre-empt them.
There are big risks in either course of action, but the damage that would be done by another big outbreak of inflation would probably outweigh the costs associated with higher interest rates and unemployment.
Financial markets, after the initial violent response to the Liberation Day announcements, have calmed, anticipating that the wiser heads (Bessent and Commerce Secretary Howard Lutnick) within the Trump administration will ensure that Trump’s trade deals end up generating positive headlines for Trump without inflicting significant economic damage and that US rates will be falling, not rising, in the second half of the year.
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Given the level of uncertainty about the outcomes of the trade negotiations already underway, the difficult ones with China that, despite the weekend discussions, aren’t guaranteed to eventuate, and the time it will take for the effects of the final tariffs to show up in the economic data, that might be overly optimistic.
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