Above everything else, President Trump is known for one thing: He is a bully. Whether or not he can get his way, he will use all the leverage and bullying tactics he has to make sure he does so. This tends to work with most countries given the sheer size of the U.S., but China is another matter altogether.
Regardless of the strong U.S. GDP growth of 3.2% in the first quarter and impressive payroll numbers, if China catches a cold, the U.S. will certainly sneeze. The fates of both countries are linked, regardless of the S&P 500 falling just 2% vs. China falling more than 6%.
This does add to Trump's delusion that he can coerce China into succumbing to all his demands. End of the day, China has its Communist Party to please -- and they are more than happy buying more soya beans or energy, but changing their constitutional law is another thing altogether. This is a country where business is done with utter respect, clearly Trump has no regard for this as he tweets his aggressive rants and disappointments, whereas China's leaders will do whatever they want in the background with a smile on their face.
Has anyone noticed the yuan fell from 6.65 to 6.80 vs. the dollar recently? If the U.S. is hell-bent on raising tariffs on China, China can easily devalue its currency to the detriment of Trump -- who will be even more angry, as their cost of exports will become cheaper. To put it simply, neither countries will benefit from an extended trade war.
Logic aside, there are always theatrics, especially going into re-election 2020, where apparently that is all that matters to win swing votes. No one really cares about the economy, which has been dwindling over the last few years despite higher asset prices.
As I mentioned earlier, the market has some very serious technical setups that have, and can, exacerbate the move lower -- which it did over the last two days after this so-called threat. Both the Nasdaq (NDX) and S&P 500 (SPY) were narrowly moving higher on lower momentum, forming a tight wedge pattern that has now broken down, raising alarm bells. The Volatility Index (VIX), after months of staying low, has also squeezed a lot higher over the last few days (from 12 to as high as 20).
As volatility rises, market indices fall. So, we seem to have unwound quite a bit of the recent overbought market. The situation from here is a lot more dire. If the tariffs are set to go through as per recent commentary, the markets will fall severely, as the massive uptrend since the start of the year will be threatened, forcing algos to switch to sell. If U.S. and China do manage to get a deal done (even a fake one, who knows?), the markets will squeeze higher and regain old highs. From here, the markets are binary.
As the S&P 500 traded below 2900, the market had a lot of "negative gamma" to deal with. What this means is that as the market moves lower, the market makers need to sell more futures to be hedged, causing the selling to accelerate. The market is being whipped by chunks of futures selling, as seen by the NYSE TICK, which registered its second-biggest program selling in the past two months.
As hard as it may be to take a step back from the Trade War tweets, the market had been derating global growth outlook via select commodities and cyclical equities since the end of April. There is no doubt that global growth is slowing, as per global manufacturing data or PMI across the board. Copper started falling before these tweets hit the tape on Sunday. It is down about 7% since the highs -- and mining stocks were down 10% before this week. Energy stocks have been underperforming over the past month, as Brent is capped at $70/bbl while production is picking up.
The unwind of the long reflation trade took place with or without Trump's threats. This is the bigger issue at hand -- we are in a world of a higher U.S. dollar and slower global growth. It was only the technology sector that kept charging higher, until this week put a dent in its trajectory.
It is important to distinguish each sector and move outside of the noise. Trump knows that a stronger U.S. dollar hurts his precious market and global trade growth. Hence his urgent demands to Fed Powell to cut rates by 100 bps. After all, he needs to come up with any way to get the S&P 500 to 3200 by 2020.
Keep an eye on FX markets, if the yuan starts falling more, then commodities will get hit regardless -- and cyclical growth stocks even more as the dollar rallies. All eyes are on Friday. If China does not go through with all of Trump's demands, Trump's plan may backfire and he will have to go ahead with the increased tariffs with his precious market falling. If China concedes, they will appear weak to the world. A compromise will serve both sides, but Trump wants nothing short of an absolute win for the U.S., which is never a good way to "broker a deal."
Maybe that is what is game plan is after all -- cause a massive wobble to give the Fed a reason to cut rates by 100 bps so that the market can squeeze massively higher into next year.