The Fed and Trump's China Tweet: What It All Means for the Markets

Before President Trump lit up social media with a barrage of tweets on Sunday, including one threatening to impose 25% tariffs as early as Friday, the biggest question facing the market was what to make of the Fed after last week's FOMC meeting. Is the Fed a still friend of the market? Or has the Fed shifted gears enough to become a headwind? The S&P 500 was at 2954 before the Fed, dropped as low as 2901 and is back to 2945. The 10-year Treasury yield was 2.45% before the Fed announcement, peaked at 2.57% on Friday after the non-farm payrolls report was released, but finished the day at 2.53%. From my seat, it felt like the market was almost desperate for a Goldilocks type of number and decided that Friday's jobs report was exactly that sort of Goldilocks number -- all the growth without any of the inflation. There is some truth to that, but I think the bigger message the Fed will be hammering home to the market in the coming days and weeks is that investors are getting way ahead of themselves on a rate cut. The probability of a rate cut in the next 12 months has dropped, but I believe a cut is unlikely to occur, and that if it does occur, equity markets will have to be lower than they are today. Friend or Foe? The good news is that the Fed is a foul-weather friend. Unlike fair weather friends who disappear at the first sign of trouble, the Fed steps to the plate. After helping cause December's swoon in markets, they have done everything in their power to promote asset inflation. Having achieved so much in such a short amount of time, look for the Fed to be less supportive for risky assets, especially now that the central bank's independence is becoming a more frequent topic of conversation even amongst casual market observers. The Fed will pay lip service to inflation creation, but they will be jawboning the market to higher yields, which I think will be accompanied by weaker equity markets. The Real Art of the Deal Now that the president brought up the possibility of increasing tariffs on China, we should review a few quick points: 1. I switched from believing the market wasn't pricing in a trade deal, to that the market was pricing in too much good news on April 10, when I sent out the first report in a long time that questioned the path we were headed on regarding trade deals. 2. I believe that markets will be hit hard if a trade deal falls apart (as something was priced in). 3. Even if a trade deal is to happen with China, we need to pay close attention to what the president does with trade deals for other countries, and all my indicators are pointing to a disruptive stance that won't help markets. 4. Tariffs are actually paid by the entity importing the product (the president's tweet made it sound like China pays the tariffs). While over time, increased tariffs may cause Chinese companies to reduce the prices of their goods to remain competitive, in the near term, that cost either hits the earnings of companies or is passed on to consumers (which in theory would be inflationary). Small companies are often more at risk than larger companies as they often have less ability to pass on costs to their customers With that backdrop, I must admit that I'm only marginally concerned that tariffs will be implemented and that there won't be a trade deal. For now, I think this may be another example where the president seems to like to blow up a deal at the 11th hour, primarily so he can personally ride to the rescue and negotiate even better terms than had been on the table (or agree to the same terms, but announce publicly that the deal terms had improved due to his threat). If that's the case, then we should see some progress toward a final deal in the coming weeks (after an extension of the newly created tariff deadline). My base case remains that we are getting a deal, but it won't be a great deal and will disappoint the market. I will be vigilant for more color on how serious the president is (I've spoken to several people close to the source and am not getting a clear answer on whether this is real or posturing, which is part of why I'm leaning toward posturing). There was little else in the tweetstorm that the president launched that indicated Washington is becoming less partisan (despite stories of infrastructure spending that excited the market earlier in the week). Bottom Line I'm still looking for: Higher Treasury yields (and steeper curves) as we price out rate cuts. Weaker equity prices (and potentially a lot weaker if trade wars on back on for real). Indifference on investment-grade bond spreads (high-yield is more of a concern).

The Fed and Trump's China Tweet: What It All Means for the Markets

This may be another example where the president likes to 'blow things up' at the 11th hour, primarily so he can personally ride to the rescue and negotiate "even better" terms.

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