Independence Wars Ahead?

In the US, core consumer prices have resumed their deceleration in April in year-on-year terms. Slower rents have helped, but even when controlling for this – and the pesky car insurance prices - the short-term momentum has flattened, in contrast with almost systematic re-acceleration since the second half of last year. It is only one monthly print though, and we need to be prudent. Yet, it is tempting to read this piece of good news on the inflation side in the context of a softer dataflow in the real economy. A disappointing number for retail sales out last week, together with the deterioration in consumer confidence, point to a more hesitant household sector.

In principle, this should trigger a divergence in the market reaction across asset classes, pushing the price of risk-free assets up, as the odds of Fed cuts are rising, but also weighing on the price of equity and credit as the economy would become less supportive. Such divergence did not materialise last week. It seems the market is pinning their hopes on a goldilocks scenario in which the Fed’s loosening – and general improvement in financial conditions – would keep the real economy robust enough to minimise any significant deceleration in profits and deterioration in credit quality. The fact that no fiscal austerity is looming in the US also helps.

Still, we want to explore the possibility that, especially under a potential second term for Donald Trump, a conflict arises between a Fed opting for a very prudent removal of the restrictive stance and a US administration ready to provide even more fiscal support next year. This is not a theoretical concern. Trump was explicitly critical of Jay Powell during his first term, at least until the pandemic, and last week a former President of the New York Fed published an Op Ed on the possibility to see the administration exert pressure on the central bank. The legislative process through which the Fed’s status could be reformed would probably be cumbersome, but the institutional set-up of the Fed is quirky, and its independence is less solidly guaranteed than the ECB’s.