Trump has a point, up to a point

The President’s continued hectoring of his central bank head doesn’t look likely to let up anytime soon. His suggestion that US interest rates should be among the world’s lowest doesn’t have any meaningful support among economists, or for that matter, in fed funds futures pricing by market participants. Economies with rates at rock bottom levels are typically those suffering a decided economic malaise, so the President should be careful about what he wishes for. But Trump does have a point, sort of.

That lies in data that, for the most part, suggest that current interest rates are too high to be sustainable over the medium term while still keeping the American economy growing at potential. A very long pause at these levels would therefore represent a threat to the Fed’s full employment target, and downward pressure on inflation.

True, rates have been at this level or higher since the start of 2023, and the economy has held up well. But that was helped by tailwinds tied to outsized wealth gains that fueled a consumption boom, support for consumption from faster immigration growth during Biden’s term, and government subsidies for chip plants and renewable power projects.

Assessing whether rates are actually near neutral in the absence of such tailwinds entails taking the temperature of the interest sensitive components of demand. There, for the most part, lies evidence that a policy rate in the mid-4% range is in fact a material drag on growth. Core capital goods orders have held up well, but overall growth in interest sensitive demand for equipment, business construction and homebuilding has been slowing over the past four quarters. (Chart).

Durables goods consumption could also decelerate as tariffs raise prices in upcoming quarters. As a result, we see the need for a further 100 bps in easing by the end of 2026 to keep the economy in gear, taking the funds rate to the mid-3% range that we see as truly neutral. So President Trump has a point, up to a point. But so too does Chairman Powell when he reiterates that he sees no reason to act just yet. His view is much easier to articulate: in the here and now, the Fed has the labour market right where it’s supposed to be under its dual mandate, sitting at full employment. Relative to its 2% core-PCE inflation mandate, the picture is more mixed, still at 2.7% in the past year, but cooler in the last three months. It’s what lies ahead that is less clear. The recent cooling has been helped by a deceleration in rent measures that we have long anticipated.

But it’s also been flattered by a huge build up in imported goods inventories in Q1 that has delayed, but not permanently forestalled, the impacts of higher tariffs. Goods with shorter inventory-turns are showing some price momentum, but vehicles and clothing on dealer lots and store shelves this spring and summer will be tilted towards items that crossed the border before April’s tariff hikes. In some cases, we might not capture tariff impacts until late summer or fall.

Having been burned once by judging supply-side inflation impacts as transient and finding them to be more persistent, the Fed has every reason to wait to see how that tariff fallout plays out. If it takes until Q4 to gain those insights, that’s a point in favour of Powell’s wait and see strategy. And a 4.1% jobless rate gives him the luxury of doing just that.

For the weekly forecast for the Canadian and US markets, see here.

Author: Avery Shenfeld, Chief Economist, CIBC Capital Markets

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