Mary Daly, the San Francisco Fed chief, hinted strongly on Wednesday that there could be three cuts this northern autumn. “We know that once the labour market stumbles, it tends to fall quickly and hard,” she said.
For now, it is a story of “low hiring”. It becomes dangerous if companies start firing as well. That can turn into a self-feeding downward spiral of mass layoffs that slips control, forcing the Fed to slash rates to the bone.
US jobs growth ground to a screeching halt in May and June, just as labour economists had predicted.Credit: Bloomberg
The US property market is already crying out for relief. Mortgage applications have collapsed to the levels of the mid-1990s. The Freddie Mac house price index has fallen for the past five months in a row. Property owners in south-west Florida are slashing prices at the fastest rate since the subprime bust in 2007-08.
Wall Street has shrugged off the slowdown, but that is because traders are betting on the “Fed put” – Vickie Chang, from Goldman Sachs, says markets have priced in both a “negative US growth shock” and a “doveish policy shock” at the same time.
The two more or less offset each other. In other words, the Fed will ensure that the Schiller price-to-earnings ratio on Wall Street remains near the peak of the dotcom bubble at over 38, and junk bond spreads remain as compressed as they were at the peak of the Lehman credit bubble. Uncle Jerome will keep investors fat and happy.
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The Fed will undoubtedly cut rates, but it is an invidious position. The next shocker may well be the core inflation figures out next week. The delayed effects of the tariffs are about to feed through with malicious and unstoppable force. Welcome to 1970s Nixonian stagflation. Donald Trump will doubtless declare that the index has been manipulated by Marxist fifth columnists. Good luck with that.
The US is unable to substitute 90 per cent of its current imports with local production. Trump’s trade taxes will be paid by US consumers via higher prices, and by US companies with plants abroad or reliance on foreign inputs via lower profit margins.
Caterpillar has already warned that the Trump levy will cost it up to $US1.5 billion ($2.3 billion) a year. Brewer Molson Coors expects earnings to fall by 7 to 10 per cent because Trump’s 50 per cent tariffs on aluminium have pushed metal can costs through the roof.
We know from early warning signals – both the ISM’s service price paid index and S&P Global’s composite PMI output prices – that price impulse is filtering through with the usual multi-month lag, and that headline inflation will approach an annualised rate near 5 per cent over the next three months.
Durable goods prices are already rising at the fastest rate since the early 1990s. The Yale Budget Lab expects food and apparel prices to rise by almost 40 per cent.
The Fed will undoubtedly cut rates, but it is an invidious position.
Britain and Europe are in a different position. They are absorbing the brunt of China’s galactic overcapacity, and absorbing some of its deflation too as a wave of cheap Chinese exports are diverted from the US and into their markets. They are not committing further economic self-harm by raising inflationary trade taxes themselves.
I can understand the reasons for the hawkish tone of the Bank of England’s rate cut on Thursday, but lingering worries of UK inflation may soon be washed away by larger global forces. “The Bank will be compelled to cut faster in 2026,” said Mathieu Savary, of BCA Research, who thinks that deflation is the greater danger stalking Europe.
The eurozone’s rebound has stalled. The growth spurt earlier this year was an illusion of “tariff front-running”.
German industrial output fell 1.9 per cent in June. It is down 4 per cent from a year ago, and 10 per cent below its pre-pandemic level. “It’s a cold shower for our long-held view of a cyclical rebound in German industry,” said Carsten Brzeski, of ING.
Brzeski said Germany’s Mittelstand family firms cannot blunt the impact of the tariffs by relocating production to the US.
These firms have always formed the backbone of the Wirtschaftswunder (or economic miracle). They are being hammered on a second front by China, which has moved up the technology ladder and is now competing toe to toe in third markets, with the help of a suppressed exchange rate.
Keynesian rearmament and a blitz of infrastructure spending will eventually lift Germany out of the doldrums.
The Merz government is swinging from a primary budget surplus of 2 per cent of GDP to a primary deficit of 2 per cent by 2028. That is a big secular shift in macroeconomic policy, but it remains far away and, in the meantime, France and Italy face fiscal retrenchment.
The eurozone has seen a long series of false dawns over recent years. It risks happening again if the European Central Bank continues to sit on its hands as the Wicksellian “natural” rate of interest plummets.
Trump’s tariffs on Europe will now ratchet up to 15 per cent. The trade shock amounts to 25 per cent this year when you add in euro appreciation against the dollar, or a de facto 60 per cent shock on metal products.
Trump has yet to drop his full pharma bomb. He is talking of 100 per cent tariffs on semiconductors. The market narrative that the worst is over and that stability will come will surely become a collectors’ item for historians and students of the capitalist psyche. Nothing is ever stable with Trump.
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He has just inflicted the biggest trade shock in peacetime since the origins of the modern economy in the 17th Century.
He has killed Pax Americana stone dead, destroyed NATO credibility, carpet-bombed the West and smashed the rules-based order to smithereens on every level. Yet asset markets remain insouciantly priced for perfection.
What can possibly go wrong?
Telegraph, London
