Last week, we had Trump causing waves with this Putin meeting, and ending the week talking about tariffs on ALL of our imports from China. We had the following weekly reaction from the markets:
- S&P was unchanged,
- ED white pack was down 0.6bps, and
- ED gold pack was down 6.4bps.
While the pricing in any given week can be all over the place (especially a low volume summer week), this was curious when Trump noticeably escalated trade tensions with China. It’s not clear to me if: (1) the markets are underestimating the potential growth tail risks of a full-blown trade war, or (2) the markets are almost certain the outcome will be benign or even favorable. Maybe the markets are like me, and waiting for calamity to be priced in so that they can go the other way. These are strange times.
What is making the tea leaves harder to read is that we had some other wrinkles to the markets and the trade war story:
- Trump suggested the Fed should not be hiking much. He was apparently concerned that the Fed may hike two more times this year. That scenario is 40bps priced in. And if Goldman is right and we get another IOER move this year, two hikes this year could be as much as “45bps” priced. Unless there is a possibility the Fed can hike three or more times this year (which seems highly unlikely, unless we get hyperinflation), the current market pricing seems aggressive. I find the suggestion by some analysts that the Fed may hike more because of Trump’s comments (to assert independence) unlikely.
- Trump started accusing the EU and Japan of currency manipulation. A weaker dollar would be one way to get more exports out of the US. Let’s see how strongly this tirade continues. It was a strange “coincidence” that the BOJ came out Friday saying they may consider making changes to its interest rate targets.
- The BOJ was one of the pillars of low longer term rates. Any changes to how they set rate could have reverberations in the long end. As per my curve inversion issue a few weeks ago, I prefer the very long end for any reflation trades.
- China hasn’t escalated via retaliatory trade policy. I continue to think they will wait out Trump until elections get closer. The lack of movement by China is probably why Trump continues to escalate. This doesn’t mean China’s given up. We will hear from them eventually.
- China is weakening its currency. That could offset some of the impact of US tariffs, and increase Trump’s ire.
- It’s earnings season. I’m not sure if stocks are just buoyant because we are in the midst of earnings season. The big tech names have yet to report. We get Amazon, Facebook and Alphabet next week, and Apple the week after that. Netflix was terrible. There could be some additional downside risks to tech: Alphabet has EU fine issues, Facebook could disappoint post-Cambridge, and Apple could address trade tariffs. We love Amazon. That could be the Kiss of Death for Bezos.
Let’s see if next week brings some more clarity to the market tea leaves.