U.S. President Donald Trump says lower rates are needed to take pressure off borrowers and to stimulate the moribund housing market.Christopher Furlong/Reuters
A friend has a mortgage that is up for renewal next February. It currently has an absurdly low rate of 1.66 per cent, negotiated after interest rates plummeted during the pandemic. He’s worried that mortgage rates will be much higher next winter than they are today and is seriously considering doing a new deal now. What did I think?
I had to tell him I couldn’t make a responsible projection. There are too many moving parts in the current equation.
If it were up to President Donald Trump, rates would be lower by February – much lower, in fact. He wants to see a cut of 300 basis points by then and is spending a lot of political capital to pressure Federal Reserve Board Chair Jerome Powell to either start the process now or get out of the way and let someone else do it. So far, Mr. Powell is having none of it.
Mr. Trump says lower rates are needed to take pressure off borrowers and to stimulate the moribund housing market. As a welcome side-effect, a cut could also result in reduced interest charges on a portion of the burgeoning U.S. national debt.
The President’s problem is that his quest for lower rates is working at cross purposes to another of his major policies – higher tariffs to protect U.S. industries and promote new capital investments.
The number one responsibility of the Fed (and the Bank of Canada) is to keep inflation under control. The introduction of high tariffs will have the effect of pushing inflation higher, perhaps much higher. The deals reached with Japan and the European Union both have a 15 per cent base rate on imports to the U.S. That’s apparently Mr. Trump’s bottom line. It’s a lot lower than the rates he initially announced on April 2, but it’s still a huge increase on the previous levies – and, therefore, inflationary.
Trump’s war on Fed Chair Jerome Powell could roil Canada – and your mortgage
We had a preview last week of what might be coming. General Motors announced second quarter earnings per share were down 17 per cent compared to last year and the company lowered its full-year guidance to include a possible hit of US$4-5-billion from auto tariffs.
That’s just a single company, albeit one that is highly exposed to the tariff war. Imagine the impact to the entire U.S. economy when Trump’s plan takes full effect. The Wall Street Journal reported last week that the U.S. has collected an additional US$55-billion in tariffs so far this year. Some or most of that will eventually be passed on to consumers.
The net result: economic growth will slow, inflation will rise, and the President’s desire for lower interest rates will become highly problematic.
But what if Mr. Trump succeeds in bullying the Fed Chair to leave earlier, opening the door to a replacement that would be more than willing to implement the President’s wishes? Under that scenario, we could see a lethal combination of sharply falling interest rates even as inflation gathers steam. The damage to the U.S. economy would be extensive.
Canada is not obliged to follow America’s lead on rates, but we usually move in the same direction. A significant drop in U.S. rates while the BoC stands pat would put strong upward pressure on the loonie, as foreign investors sought to profit from the higher returns offered by Canadian bonds. A higher loonie would only exacerbate our trade problems with the U.S. by boosting the cost of our exports.
Interestingly, the stock markets seem blissfully unconcerned about all this drama. Nasdaq, the S&P 500, and the S&P/TSX Composite all touched new record highs this month. But some indicators suggest investors should be prudent.
The stock market is booming. Our economies are busting. What’s going on?
The Conference Board’s Leading Economic Index for the U.S. dropped 0.3 per cent in June after holding steady in May.
“For a second month in a row, the stock price rally was the main support of the LEI,” said Justyna Zabinska-La Monica, Senior Manager, Business Cycle Indicators, at The Conference Board. “But this was not enough to offset still very low consumer expectations, weak new orders in manufacturing, and a third consecutive month of rising initial claims for unemployment insurance. In addition, the LEI’s six-month growth rate weakened, while the diffusion index over the past six months remained below 50, triggering the recession signal for a third consecutive month.”
The Conference Board is not forecasting a recession at this point but is warning of slower economic growth in the coming months. It expects U.S. GDP to grow by 1.6 per cent this year “with the impact of tariffs becoming more apparent in H2 as consumer spending slows due to higher prices.”
A slow growth scenario would push the Federal Reserve Board towards the easing policy the President so desperately wants. But if the slowing economy and higher prices result in the emergence of the dreaded stagflation, all bets are off. The last time this happened was in the late 1970s-early 1980s. Before the central banks could get control of the situation, mortgage rates had skyrocketed. They peaked in Canada at around 21 per cent in 1981. No one wants to see that again, but given the forces currently at work, we can’t rule it out.
My friend with the mortgage has a tough decision to make. So will we all if the President gets his way.
Gordon Pape is editor and publisher of the Internet Wealth Builder and Income Investor newsletters.