Guarded But Not Bearish

President Trump’s recent announcement that tariffs on Mexican imports would be “indefinitely suspended” was a rare piece of good news which helped sustain a relief rally for equities last week.

It remains challenging, however, to peer through the fog of war of global trade. Only three days later, Trump tweeted that Mexico “tariffs will be reinstated” if the Mexican congress does not approve the immigration deal. 

It is also questionable if Trump’s latest hardline threats to immediately slap tariffs on remaining Chinese imports if President Xi does not meet him at the Osaka G20 are constructive at all. Xi would be reluctant to appear weak to his own base by appearing to give in to Trump, especially as intensifying protests in Hong Kong further complicates the political situation at home. 

While it is a difficult call, our baseline scenario remains that Xi and Trump will meet at the G20 and agree to continue talks, and that part of the threatened final round of US tariffs could be implemented in mid-July or after.

The most recent disappointing US payroll numbers for May (only 75k versus 180k consensus) also raises the question of whether the US economy is already feeling the impact of trade uncertainties. There is no definitive answer as yet: Monthly fluctuations cannot be read too deeply into; widespread flooding in the Midwest also seems to have depressed the May number; and the 3-month and 6-month averages remain well above the breakeven pace of 100k jobs.

These shifting cross-currents of trade and economy underscore the difficult job that the Fed has at this juncture – especially given pressure from market pricing that reflects a near certainty of Fed rate cuts by the end of this year.

We see the Fed cutting rates in 2H 2019 but the timing will be dependent on their assessment of the economic outlook and the direction and impact of trade tensions. In our view, the Fed is unlikely to cut rates this week before obtaining more clarity on trade from the Osaka G20 summit later this month. That said, even if its rate policy remains unchanged this week, we expect the Fed to open up the option of cutting rates ahead by dropping the word “patient” to eliminate an implicit hiking bias and making changes to their forecasts.

Post Feb 1994, when the Fed began to announce rate decisions under Greenspan, the Fed has put forth four sets of rate cuts – starting Jul 1995, Sep 1998, Jan 2001 and Sep 2007 – and history shows the market tends to anticipate and rally before these first rate cuts. Against this backdrop in which the market expects a rate cut ahead, the oft-cited “bad news is good news” dynamic kicks in. A striking example of this is how on 7 June the remarkably weak payroll number (bad news) reinforced market expectations that the Fed is more likely to cut rates (good news), and subsequently drove a 1.5% rally in the S&P 500.

Given that the Fed Put is well and alive, despite significant uncertainty over the direction of trade tensions and its economic impact ahead, we believe a neutral stance in terms of overall risk positioning is appropriate but do not see strong grounds to be bearish.