What are the chances? Two of the pivotal points for the financial markets in the past several months has been US-China trade relations and Federal Reserve monetary policy. Both issues have been shifting this week.
The US has made a series of quick, yet small concessions in the trade dispute with China. While we have seen this pendulum swing back and forth many times, the equity market seems to believe that “this time could be one” every time.
And why not? A report from the Federal Reserve recently estimated that the drag on economic growth from the uncertainty could be as much as 1% annualized which would otherwise have growth rates closer to the 3% mark rather than struggling to get to 2%. Not to mention that some voters who support the administration are starting to believe the approach to China is doing more damage than good. Finding a way to settle matters for the moment, though not addressing the core issues of intellectual property protection and market balance in the geopolitical power balance, would go a long way to help the re-election process as voters decide with their wallets.
Meanwhile, the absolute certainty implied in the interest rate markets of a Fed rate cut this coming Wednesday has started to waver. Not much mind you. Fed futures suggest a mere 10% chance of no-action now and single digit probability for no action through the end of the year, but it is a marked change from only one month ago.
The change in probabilities is not entirely unrelated to the softening on trade. While market participants have long been confident of Fed easing, we have noted that Fed policy makers have said nothing to support the view. If anything, the comments from Fed officials since the Julymeeting have been counter to a cut citing anything from solid economic data to the risk of unintentionally inflaming trade tension further by counterbalancing the growth drag. Not to forget that it was a split Fed decision to ease last meeting.
As the yield on the ten year US Treasury rises, we agree there is a risk of disappointment. It is not our base case, and could possibly be the “policy mistake” in this cycle, but if it happened the equity market could be out of luck in the short-term.
Will Skeean, CFA
Partner – Investment Management Team Chair