US stocks on Friday logged their first two-week losing streak of 2019.
A late-session swoon predicated on a largely superfluous CNBC “scoop” didn’t help matters.
As you can surmise from the annotation in the bottom panel, CNBC’s “scoop” wasn’t really a “scoop”. Talks with China effectively “stalled” minutes after Donald Trump opened his Twitter app two Sunday evenings ago to inform the world that the US would be more than doubling the tariff rate on $200 billion in Chinese goods within five days.
Although Liu He still made the trip to Washington, everyone knew a deal would not be struck. This week, things got materially worse. Wednesday will be remembered for Trump’s Huawei broadside, which, for all intents and purposes, makes it impossible for Xi to make further concessions without appearing weak domestically.
Meanwhile, China’s vast state media apparatus worked day and night to shape public opinion. One message that came through loud and clear is that unless Washington comes around to Beijing’s relatively modest terms and agrees to negotiate in good faith towards a deal that allows China to come away with its dignity intact, Trump can forget it.
So, it shouldn’t have come as a surprise to anyone when CNBC reported that “scheduling for the next round of negotiations is ‘in flux’ because it is unclear what the two sides would negotiate.”
That’s according to two sources briefed on the status of the talks, who also said “China has not signaled it is willing to revisit past promises on which it reneged earlier this month, despite showing up for talks in Washington last week.”
As a reminder, the veracity of US officials’ characterization of China as “reneging” is up for debate. Beijing called that “bandit logic” on Thursday.
In any case, CNBC’s story was enough to send traders off to the weekend on a sour note and you can be sure everyone is warily eying next week after the onshore yuan pushed through 6.90 Friday.
“One of the take-aways from our visit to North America last week was that we’re now confronted with tweet-driven markets, making our strategies more vulnerable than in past cycles and certainly complicating our lives”, SocGen’s Alain Bokobza lamented on Thursday, adding the following:
The hawks appear to have taken over in Washington, but the free trade lobbies are by no means absent from the debate. We take this new episode of the trade war very seriously and see it as price sensitive for many quoted assets – although at this stage we think an imperfect compromise will be reached over the next few weeks. We need to learn to live with this situation, as we will certainly not be going back to square one – we’re still more than a year away from the US elections and Trump has been faring well in the polls lately.
That’s a nice segue into Marko Kolanovic’s straightforward assessment of the trade situation as it relates to the 2020 election.
Everyone knows an economic downturn would be bad for Trump during an election year. In addition to being common sense and applicable to any president, it’s especially relevant for Trump for a number of reasons, not the least of which is that he ran in part on the idea that his purportedly “legendary” business prowess would help usher in a veritable economic renaissance in the US (note: in addition to being dubious on its face, Trump’s claim to extraordinary business acumen has since been called into question by a number of investigative reports).
Additionally, economists have long warned that Trump’s fiscal policies were dangerous and that his trade policies were potentially ruinous. So far, the president has skirted danger, in part because the overheating labor market has not translated into inflation pressures and late-cycle fiscal stimulus has shielded the US (both the economy and markets) from turmoil abroad. If that’s no longer the case by 2020, well, Trump’s chances of reelection would wane.
JPMorgan’s clients are unsurprisingly curious to get the bank’s take on all of this.
“Based on the current polls, it seems most likely that the presidential candidates will be Trump and Joe Biden [and] it also seems that Trump stands a good chance to get re-elected unless there is an economic deterioration in the US”, Kolanovic writes, adding that “despite the ongoing stimulus in China and a solid US economy, it’s possible we could have a slowdown or a recession if the trade war escalates further, which would likely lower Trump’s chances of winning in 2020 due to the potential selloff in US stocks, direct GDP impact of trade breakdown, increasing consumer price inflation, etc.”
You’ll recall that Goldman’s analysis shows the potential peak hit to GDP from a worst-case scenario that finds the US going pedal-to-the-metal on protectionism and equities falling 10%, would be roughly 0.8%. Here’s the key passage (from a note dated May 11):
The growth impact would increase under further escalation. Adding both the final round of tariffs on Chinese imports and the auto tariffs results in a peak hit to the level of GDP of 0.4%, with the hit to growth spread out over several quarters depending on the timing of the escalation.
Another potential risk is an amplification of the direct economic impact by a major deterioration in risk sentiment. The level of anxiety about the trade war in US financial markets has varied over time. The broader market reaction to trade war news was quite strong in the early stages, but then faded later in 2018 before showing signs of life again this week. In short, while the market reaction to further escalation is hard to predict, a larger sell-off is a potential risk. A 10% decline in equity prices, for example, would roughly double the peak hit to the level of GDP in the risk scenario to about 0.8%.
Last year, when Trump’s criticism of the Powell Fed went into overdrive, the president repeatedly described the central bank as the biggest risk to his presidency. Despite the Fed’s best efforts to accommodate the White House in 2019, Trump is still unsatisfied. He lambasts Powell every chance he gets and last week, he suggested the Fed should participate in the trade war by “matching” PBoC easing. That underscores how obsessed the White House is with the economy and stocks (and not necessarily in that order).
Larry Kudlow (who has been a key part of Trump’s efforts to influence Fed policy), has to hear about it every time stocks fall. “Any time the markets go down, Trump bothers Larry”, a person close to Kudlow told Vanity Fair’s Gabriel Sherman for a piece out Thursday. Sherman went on to suggest that Kudlow wants out:
While Kudlow is telling friends he’s “having the time of his life,” he’s also eyeing an exit. According to sources, Kudlow wanted to leave the White House this summer, but Kudlow agreed to stay after Trump said he didn’t want Kudlow leaving until the China trade war was resolved. “I need you here for the markets. We need a united front,” Trump said, according to a source. (A White House official said Kudlow has no intention of leaving.)
JPMorgan’s Kolanovic reminds you that Kudlow knows full well that tariffs can be damaging.
“One should keep in mind that academia, businesses, and central banks have written extensively on the counterproductive impact of trade tariffs”, Marko wrote Thursday, before noting that “this was well summarized by the late president Ronald Reagan and more recently Larry Kudlow.”
Stocks, Kolanovic says, are trying to tell the administration that “the trade tariff approach is likely detrimental to the value of US businesses and hence the US economy.”
It’s also not lost on Trump that China has the scope to support its markets and economy with fiscal measures and a literal plunge protection team.
All of that, Marko said this week, suggests “the trade war will get resolved and that the latest trade escalation is just a short-term hurdle, before favorable terms for the US are reached.”
Of course that’s just the base case. And irrespective of that, Marko cautions that “investors should keep monitoring the risk of a miscalculation by either side.”