When Trump And Xi Seek A War-Ending Trade Deal

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Now, even the Federal Reserve is calling Trump's bluff. In a speech on Wednesday, Fed Chair Jerome Powell threw cold water on Trump's expectation that lower US rates would ease the pain from tariffs.

“These are very fundamental policy changes,” Powell said.“There isn't a modern experience of how to think about this.”

The problem, Powell said, is that“the level of the tariff increases announced so far is significantly larger than anticipated” and that uncertainty around where tariffs may be heading could inflict lasting economic damage. That includes higher inflation and weaker household demand.

“Jerome Powell just laid down the law with Trump,” says David Russell, global head of market strategy at TradeStation.“It was a clear warning about stagflation, and a declaration that the Fed won't enable the White House with rate cuts .”

The risk the US is heading into a high inflation-flatlining growth period is a fast-growing challenge for the Fed.

As Austan Goolsbee, president of the Chicago Fed, puts it,“a tariff is like a negative supply shock. That's a stagflationary shock, which is to say it makes both sides of the Fed's dual mandate worse at the same time. Prices are going up while jobs are being lost and growth is coming down, and there is not a generic playbook for how the central bank should respond to a stagflationary shock.”

Cleveland Fed President Beth Hammock adds that“this is a difficult set of risks for monetary policy to navigate. Given the economy's starting point, and with both sides of our mandate expected to be under pressure , there is a strong case to hold monetary policy steady in order to balance the risks coming from further elevated inflation and a slowing labor market.”

Powell said that if stagflation becomes a reality,“we would consider how far the economy is from each goal, and the potentially different time horizons over which those respective gaps would be anticipated to close.”

This nascent Trump-Fed standoff weakens the White House's hand heading into China trade talks.

Global funds turning on US government debt is already chastening the Trump White House. The specter of 10-year yields approaching 4.5% is drawing the attention of credit rating agencies, not to mention Asian central banks holding roughly US$3 trillion of US Treasuries.

The last time the US bond market flashed such warning signals was March 2020, just as the pandemic was taking hold.

Fortunately, says economist Nellie Liang at the Brookings Institution, the Fed's purchases back then to restore market functioning were aligned with its monetary policy objectives at the time – to stimulate the economy and raise inflation to its 2% target.

“It's possible, however, that the Fed may someday confront the need to purchase Treasury securities at a time when doing so would conflict with achieving its mandate of maximum employment and price stability,” Liang says.“Avoiding this conflict underscores the importance of regulatory reforms to strengthen Treasury market resilience.”

With US Congress essentially gridlocked amid partisan sniping, the odds of such upgrades are near zero.

In the meantime, bond vigilantes are letting Trump know that his tariffs are a clear and present danger to US financial stability. And wild swings in the US stock market are hurting Trump's approval ratings with voters, a problem Xi doesn't face.

Advantage Xi, whose far more rigid system also leaves China less susceptible to a massive capital flight as investors try to vote with their feet.

“If doubts about the exceptional status of the dollar were to increase, this would be very credit negative for the US,” says Alvise Lennkh-Yunus, head of sovereign ratings at Berlin-based Scope Ratings.

Not surprisingly, China's two top leaders are taking China's charm offensive on the road. Xi is in Southeast Asia, which is now his economy's top trading partner.

In Hanoi, Xi and Vietnam's Communist Party Secretary-General To Lam agreed to“jointly oppose unilateral bullying” amid trade jousting. Trump hit Vietnam with a 46% tariff on his April 2“Liberation Day” announcement.

The official Xinhua news service quoted Xi as saying that“we must strengthen strategic resolve and uphold the stability of the global free trade system as well as industrial and supply chains.”

Stephen Olson, a former US trade negotiator, told the BBC that Xi's comments were“a very shrewd tactical move. While Trump seems determined to blow up the trade system , Xi is positioning China as the defender of rules-based trade, while painting the US as a reckless rogue nation.”

In Phnom Penh, Xi pushed the idea of an“Asian family” that can harness regional unity for greater stability and unity. Written between the lines in bold font was Trump's divide-and-conquer strategy targeting economies from the biggest industrialized ones to those in the Global South.

Premier Li Qiang, meanwhile, has been working the phones in Europe, China's second-biggest market. Li and European Commission President Ursula von der Leyen discussed, according to the EU side,“China's critical role in addressing possible trade diversion caused by tariffs, especially in sectors already affected by global overcapacity.”