Trump versus the Fed

We already knew that Donald Trump's understanding of economics was, to put it politely, limited.  His trademark combination of insanely stimulative fiscal policy and tariff wars may be giving the US economy an adrenaline shot in the short term, but in the longer term it's a recipe for problems, quite possibly including a full-blown financial crisis.  That crisis would most likely unfold with tariffs and a tight labour market leading to an upsurge in inflation, prompting the Fed to tighten interest rates more aggressively, resulting in a sharp rise in bond yields and a corresponding downturn in equity markets.

Some of those effects are already starting to be seen, even if this week's sudden equity selloff proves short-lived.  Prices and wages are rising and the Fed is promising to react, as it should -- and Trump doesn't like it one bit.  He has been complaining quietly about the Fed's gradual policy tightening for some time, but this week he has turned the volume up to 11, accusing the Fed of "going loco". 

It's possible, as Jordan Weissmann seems to argue here, that Trump is just distancing himself from the Fed's actions so that he can blame the central bank if (or rather when) things go off the rails. Given Trump's bull-in-a-china-shop approach, however, it's quite possible that he is setting the stage to do something much more drastic, like firing Fed Chairman Jerome Powell and replacing him with someone more pliable.

The fact that this possibility is even remotely plausible is a clear indication of Trump's lack of understanding of economic policy and markets.  With other key elements of US policy, notably fiscal and trade,  having already gone loco, to use Trump's own phrase, the assurance of a stable hand at the Fed is one of the key factors keeping market participants from panicking. 

If Trump continues to rail against the Fed, he will trigger exactly the kind of rout in fixed income and equity markets that he wants to avoid. Maybe there are calming voices among Trump's White House team that can rein him in, but as that team includes Larry Kudlow and Peter Navarro, you can't blame investors for feeling uneasy.