Why Markets are Having Problems

The primary reasons for the large losses and high volatility in US stock markets lately are as follows:

1. Trump’s tariffs have lowered real GDP.  Many companies are smarting from tariffs on steel and aluminum, as well as on imported components, along with retaliatory tariffs on their exports to China, for example.  To make things worse, the tariffs have helped slow economic growth in China, further weakening demand for US exports there.
2. The Federal Reserve has not been loosening monetary policy to offset lower NGDP resulting from tariffs and other factors, and in fact has been both actively and passively tightening monetary policy.
3. The government shutdown doesn’t help, when the Fed is already tightening monetary policy.  It can at least temporarily further reduce aggregate demand.

There is no doubt in my mind that Trump underestimates the cost of tariffs and overestimates any benefits of China further opening markets to American business.  Sure, more openness would be nice, but is it worth a recession?  Not even close.  There are better ways to incent China to open up.

By the way, markets aren’t currently indicating a recession is on the horizon, but they do indicate that GDP growth is now expected to bemore than 1% slower than expected just a few months ago.  That would still give us positive growth for 2019, but roughly cuts that growth in half.

Unfortunately, for the time being, there’s no reason to believe Trump will cease hitting the economy with real shocks to which the Fed will fail to appropriately respond.  There’s likely more turbulence ahead.