Why the Fed and ECB are no longer on the same page
ECB president Christine Lagarde has warned that trade tensions could lead to greater volatility and risk aversion in financial markets, which could weigh on demand in Europe and would also act to lower inflation.
Most exports to the US face a 10% tariff, and levies could rise to 50% if the European Union and the US don’t reach a deal by the White House’s July 9 deadline.
A fragmentation of global supply chains could also raise inflation by pushing up import prices and adding to capacity constraints in the domestic economy, Lagarde added.
Unlike the US, Europe’s central bank does not have a dual mandate. The ECB only targets inflation, while the Fed has to maintain both stable prices and maximum employment.
Fed Chair Jerome Powell and many of his colleagues this year have repeatedly urged caution and patience on rates, saying they expect Trump's tariffs to push inflation higher and drag down growth, putting the Fed in a challenging spot.
But a divide is emerging within the Fed about whether to hold rates steady for some time or get more comfortable about cuts later this year as officials try to determine whether any inflation coming from Trump's tariffs will prove to be longer-lasting.
Some policymakers are arguing for "looking through" the impact of the duties as temporary, a stance that would leave the door open for cuts. Many on the rate-setting committee, however, believe there is a risk that inflation from tariffs could become more persistent.
“If we had a good Fed chairman, you would lower rates,” Trump told reporters earlier this week. “And you know what? If inflation happened in a year from now or two years, let them raise rates.”
The president stressed that the US has a lot of debt coming due and lower rates would mean lower interest expense for the US.
“If this guy would lower rates, we get a lower interest rate. It's unbelievable,” said Trump. “And he's worried about inflation.”
The World Bank warned this week that heightened trade tensions and policy uncertainty are expected to drive global growth down to 2.3 percent this year, nearly half a percentage point lower than the rate that had been expected at the start of the year and the slowest pace since 2008 outside of outright global recessions.
The international body said turmoil has resulted in growth forecasts being cut in nearly 70% of all economies — across all regions and income groups. However, a global recession is not expected.
Dustin Reid, chief strategist for fixed income at Mackenzie Investments, which has $150 billion in assets under management, said he thinks "the ECB may need to go a bit lower" with its rates. "Tariffs are going to be quite challenging for the European Union,” said Reid.
On the Fed side, Reid thinks September is in play for a Fed rate cut.
“I do think the labor market data in the US is cracking a bit,” said Reid, adding that he “would not be surprised" if Powell this coming week keeps "a little bit of an open door [to] at least keep July in play.”
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