For Fed, sell-off could point to fading Trump stimulus

A three-week stock market sell-off may signal concerns that the massive stimulus from U.S. tax cuts and government spending will fade sooner than expected, a central issue for the Federal Reserve as it considers when to halt interest rate hikes. For now, a more than 7 percent fall this month in the S&P 500 index, which on Tuesday tumbled to July levels, is unlikely to derail plans for more U.S. monetary tightening in December, according to Fed policymakers.

Yet the sell-off, propelled by worries over rising tariffs and earnings of U.S. companies doing business in China, could begin to convince the Fed to scale back plans to continue rate rises next year and even in 2020. More selling in the weeks and months ahead could begin to split what is currently a remarkably unified central bank between policymakers more and less willing to heed a warning from investors: that the hot U.S. economy cannot withstand the combination of trade-related knocks to global growth, rising prices and higher borrowing costs.

The economy expanded at an annualized 4.2 percent rate, more than twice its potential, in the second quarter as President Donald Trump’s signature fiscal stimulus of $1.8 trillion in tax cuts took hold. Since then it has likely cooled a bit but the Fed expects it to grow a still-robust 2.5 percent next year, when policymakers predict the beginning of a smooth return to more normal economic growth.

Goldman Sachs economists estimated the half percentage-point boost to economic growth from higher stocks earlier this year disappeared in October. A further 10 percent market drop would add to the drag and, coupled with “waning” fiscal support, could push growth below the economy’s potential of about 2 percent next year, the bank said. Before March, when the first of the recent tariffs were announced on Chinese goods, the 23 U.S. companies most exposed to China had easily outperformed peers in the S&P index. But since then fortunes have sharply reversed and they have lagged peers by nearly 15 percent, according to Fathom Consulting.