In this video, Liontrust’s Phil Milburn discusses the impact on bond markets of the pressure on the Federal Reserve Chairman, US debt and the weaker dollar, and why ultimately the economic outlook depends on the US consumer
Simon [00:00:11] I'm Simon Hildrey and with me is Phil Milburn to talk about economics and bond markets in the US. Phil, what impact has tariffs both real and withdrawn had on the US?
Phil [00:00:25] So far, the tariff impact is just starting to feed through. If you look at June's consumer price inflation data in the US, goods price inflation excluding autos, which is very volatile, actually came in at 0.5% on the month. So it's now starting to come through with those sub-sectors that are very much import driven, so appliances, toys, etc really starting to see a spike in prices. I'd expect more to come in July's and August's data as we see that real hump in tariffs come through.
Simon [00:01:00] And what impact is this having on the Fed?
Phil [00:01:02] Very much the Fed is in wait and see mode. The Fed doesn't really care about this one hump in inflation, it's a one-off jump, but the Fed is still having to rebuild credibility for having called the previous jump in prices transitory. The problem here is services inflation, which became very, very sticky in the post-COVID lockdowns lifting time. And services inflation is finally getting back down towards acceptable levels, and the Fed has a razor-sharp view on will services inflation pick up again? And this is very much driven by the strength of the US labour market. If the US labour market is strong, then US staff will be able to demand higher wages to compensate for those high goods prices coming through. If the US labour market is weak, then it will be that one-off transitory hump. So hence why the Fed is just waiting to see what happens over the coming months and whether there is any what they call second order impact of tariffs.
Simon [00:02:04] And how de-stabilising is President Trump's criticism of Powell and the fact that he's not reducing interest rates quicker?
vPhil [00:02:12] Central bank independence is one of those things that you just cannot meddle with, particularly when you really need the bond market. So Trump going after Powell, it's more the symbolism, that constant barracking, and he's trying to get him by the back door as well, trying to accuse him of some just cause to do with overruns on cost building, renovating the Fed buildings. So he's desperate to get rid of him. And this is Trump, he always sulks if he doesn't get his own way. The problem for Trump is this is counterproductive. If he gets rid of Powell, at the very, very short end of the rates market, the market might move to discount the slightly higher chance of a rate cut. But anything longer maturity will sell off as the market gets terrified that Trump will interfere too much in the Fed. However, it's going to be really hard for him to interfere too much. The FOMC, who sets rates, Federal Open Markets Committee, is made up of many members. Getting rid of the chair won't affect the votes of the other members. In fact, it will probably make them dig in more. So it only marginally impacts the chances of a rate cut and makes the bond market vigilantes extract more yield, extract more term premium for risk for longer dated bonds.Simon [00:03:31] And there's been quite a lot of chatter about the debt in the US. What is in medium term threat to that?
Phil [00:03:39] The US is running an out of control fiscal policy. That is just an economic fact. With a fiscal deficit of 6.5% to 7%, that cannot be sustained. The check and balance on this in the States, in the budgetary process, is a dreadful bit of policy called the debt ceiling, which gets removed, suspended, or lifted every few years. In Trump's 'one big beautiful bill', it was lifted by about $5 trillion. At the current run rate, that will mean it won't be combining again for about two and a half years. But in the meantime, the interest expense is taking up more and more of the US fiscal budget. So at some stage, the right thing has to happen; taxes up or spending down or a mixture of both. But for the moment, the US is able to take advantage of its privileged position as the world reserve currency and still attract international flows to help finance that fiscal largesse.
Simon [00:04:36] So do you see the weakening of the dollar that we've seen this year, do you see that as a temporary thing?
Phil [00:04:41] I very much see it at the moment as the US almost acting as a safety valve. And Trump does want a weaker dollar. He's talked openly about what is now referred to as the Mar-a-Lago Accord, almost an agreement that everyone else will let the dollar weaken. But it can only weaken so far before it starts causing other problems. Imported inflation into the US or imported disinflation into other countries. The eurozone being a prime example there. So as much as the dollar should be set to weaken further, it has the support of the Fed's 'wait and see' mode from an interest rate, from a yield perspective, and it does feel like a lot of the fear about Trump has been reflected in the dollar rather than just the bond market. So on a longer-term basis, I actually think the dollar is now starting to offer reasonable value on a purchasing power parity basis.
Simon [00:05:38] So all those factors we've talked about, does that make you more cautious about the US economy going forward or no change at all?
Phil [00:05:46] The biggest influence on the US economy is still the US consumer. Roughly two thirds of GDP is consumption. Consumption will slow, mostly because of the tax on the consumer that tariffs effectively create. Ultimately, it is US businesses and US consumers that will be paying the tariffs. There might be some substitution of business into domestic activity, but that takes a long time. So the consumer will slow, but it's unlike the consumer completely collapses. So I still think we'll see a slowdown. A recession is conceivable, not that likely, but conceivable but a deep recession is highly unlikely.
Simon [00:06:27] Thank you Phil and thank you for watching. We'll see you next time.
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