The U.S. stock market is celebrating its best start to a new year since 1987. One big factor that drives this rally is the flexibility coming from the White House to delay the March 1 deadline to raise tariffs on $200 Billion of Chinese exports from 10% to 25%. I am no fan of tariffs. Global trade declined at the end of 2018 – which is what tariffs are designed to accomplish – less trade and slower growth. So it is a good thing that President Trump, due to progress in the trade negotiations with China, showed flexibility by delaying the increase in tariffs he had planned.
Flexibility and the Fed (Part One)
The Fed has put its interest rate increase plan on hold as another example of flexibility boosting the 2019 market. As cited in the February 6 Wall Street Journal, Dr. Mary Daly, the new head of the San Francisco Federal Reserve, said there is a good chance the Fed won’t raise interest rates at all in 2019. This is a big change from the expectation not so long ago that the Fed would raise rates at least twice in 2019. Dr. Daly expects the U.S. economy to grow by 2% with 1.9% inflation in 2019 – so there is no case for a rate increase.
Flexibility and the Fed (Part Two)
The Fed is also considering more flexibility in how it views its inflation target of 2%. It has been difficult for U.S. inflation to stay at 2% and above. As measured on February 13, inflation fell to 1.6% from the 1.9% number in January. The Fed tries to control inflation by increasing or decreasing interest rates. When inflation is rising strongly above the 2% target, the Fed will increase interest rates to slow down the economy and bring inflation closer to the 2% target. When inflation is declining along with a decline in U.S. economic growth, the Fed will decrease interest rates to stimulate growth. It is good that the Fed is considering giving inflation more room to run above 2% without raising rates to slow it down. The tightness around the 2% target may be causing economic growth to run too slow.