Columbia Threadneedle: Trade talk and Fed policy

14 november 2018

Colin Lundgren: Global Head of Fixed Income

Trade may be top of mind for some investors, but is it top of mind for the Federal Reserve?

Recent changes to US trade policy mark a significant departure from the trend toward lower tariffs which has been in place since the 1930s. How should investors position for the risks and opportunities presented by this new policy landscape? We examine the impact on fixed income through the lens of Fed policy. Recent Fed speak suggests it is highly focused on communicating the transition from forward guidance to data dependence as policy approaches neutral next year. They also frequently comment on the impact of a flattening yield curve and risks to inflation and financial stability from an economy growing above potential due to a late cycle fiscal stimulus.

So, how does trade policy fit into this mix? We expect the Federal Open Market Committee (FOMC) to watch for downside risks from trade in financial conditions, employment, growth and inflation data before changing the current pace of monetary tightening. Fed chair Jerome Powell underscored this view in testimony to Congress this summer: "… it is difficult to predict the ultimate outcome of current discussions over trade policy … we see the risk of the economy unexpectedly weakening as roughly balanced with the possibility of the economy growing faster than we currently anticipate."1

We think it is too early to draw conclusions, but trade agreements could impact currencies, inflation and global growth expectations, and may influence Fed policy decisions. With a high degree of uncertainty, we follow the Fed's lead and stick with what we know to form our views and strategy.

Too early to draw conclusions

President Trump appears determined to renegotiate terms with a wide swath of trade partners in order to "level the playing field". That said, proposed terms and negotiating tactics should not necessarily be taken at face value