“Happy Xmas (Trade War Isn’t Over)”, a characteristically colorful Michael Hartnett wrote late last week, in the latest edition of BofA’s popular “Flow Show” weekly.
It would be both correct and incorrect to say the week ahead will be all about trade. The Fed is on deck, and so is the ECB. And then there’s the UK election. Those are marquee events, but if Donald Trump decides to wrong-foot markets by going ahead with more tariffs (or even suggests as much), there’s a strong argument to be made that nothing else will matter for risk assets – or at least not in the near-term.
“A short bout of profit-taking on trade fears [was] a timely reminder that a US-China trade deal [is] still the #1 risk catalyst for markets and resolution [is] not guaranteed ahead of December 15th tariff deadline”, Hartnett went on to write, before making a crucial point. “[There’s] scant evidence of trade tensions de-escalating without [a] combo of Wall St pain (i.e. falling equity markets) and Main St pain (i.e. rising jobless claims)”, he said.
In other words, two things have traditionally been necessary to force a trade deescalation from Trump: Plunging stocks and signs of weakness in the domestic economy.
That makes the current situation especially precarious. November’s blockbuster jobs report will likely lead the White House to conclude that the factory slump conveyed by ISM manufacturing is something of a “false positive”. The huge divergence between ISM and Markit’s gauge could conceivably be used to bolster the case.
Meanwhile, stocks are perched near the highs. “The fact that equity markets have run up reduces the likelihood of a deal, with past market peaks followed by major trade escalations”, Deutsche Bank wrote early last week, underscoring the point.
BofA’s Hartnett drove it home last Thursday. “A lack of pain suggests payrolls of >140k & <200k [is] the likely sweet spot for macro & trade deal bulls”.
Payrolls came in stronger than that upper bound on Friday, but with wage inflation still subdued, nobody is particularly concerned about a hawkish Fed – especially not after Jerome Powell’s explicit promise not to even think about a rate hike unless there’s a material acceleration in inflation.
“We expect a ‘Phase I’ deal to only be signed early next year, though with a postponement of the planned December 15 tariff hikes”, Barclays said Sunday. “While the US and China have indicated that they are close to reaching a deal, a number of issues remain outstanding, and there is added complexity from the approval by the US House of Representatives of the ‘Uygur Intervention and Global Humanitarian Unified Response Act’ and ‘Hong Kong Human Rights and Democracy Act'”.
There is no real “consensus” (per se) on what a delay without an interim deal would mean for equities and other risk assets. The prospect of Trump moving ahead with the December 15 duties still seems almost unthinkable, but a postponement of that escalation without any accompanying rollback of existing levies is well within the realm of possibility.
If you ask us, stocks aren’t priced for that, let alone for the return of “countercyclical protectionism” proper.
On that note, we’ll leave you with a quote and chart from a BofA note out over the summer:
Weak markets motivate friendly policy and strong markets do the opposite. [Countercyclical protectionism] is not entirely new. It is conceptually similar to traditional countercyclical monetary and fiscal policymaking. For example, markets are stronger when they expect a dovish Fed, but strong markets (and a strong underlying economy) tend to make the Fed more hawkish.