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 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. 3M and Caterpillar both pointed toward these factors last week as reasons for poorer than expected quarterly results.

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.

“It’s pretty clear that the market is saying that it feels the Federal Reserve is being too hawkish,” said Oliver Pursche, chief market strategist at Bruderman Asset Management.

David Gilmore, partner at FX Analytics in Essex, said: “Markets are starting to wonder if the good times generated from Trump’s tax cuts and deregulation are in the rearview mirror.”

The economy expanded at an annualized 4.2 percent rate, more than twice its potential, in the second quarter as President Donald Trump’s fiscal stimulus of $1.8 trillion in tax cuts took hold. Since then it has cooled a bit but the Fed expects it to grow a still-robust 2.5 percent next year. Hints of inflation and a muscular labor market have allowed the Fed to settle into a gradual, quarterly rate-hike cycle.

But now the Fed needs to identify when Trump’s fiscal policies, which could boost productivity, are eclipsed by his trade policies, which could spark inflation. The answer may determine whether rates, now just above 2 percent, ultimately rise to nearly 3.5 percent, as officials predict.

“We have to be mindful of whether the economy can really stand on its own moving forward, or whether it has been propped up by other things that when they are removed would reveal some weakness,” said Atlanta Fed President Raphael Bostic.

 

Spicer and Schneider write for Reuters.