US – China fears resurface, but the S&P shrugs off concern, for now

The trouble with Fed minutes being released more than two weeks post the actual Fed meeting, is that they are redundant at best and out of date at worst. The release of the Fed minutes this evening suffered from the former affliction, the minutes stated that political risks had fallen, mere hours after fears that the US/China trade war could flare up again dominated financial markets on both sides of the Atlantic. Stocks fell sharply on the news, yields on government debt fell, and, unless this latest issue is resolved, then it won’t be long before the market starts to price in another Fed rate hike. 

What next from the Fed? 

Overall, the Fed minutes from the October 31st meeting stated that the fed was on pause for a prolonged period, that the economy was showing signs of improvement and that political risks had fallen. The Fed erred on the side of caution by noting that low interest rates could stoke excessive risk taking and asset price inflation at these current levels. However, back then the Fed and the market thought that the worst was over for the US/China trade war, hence the “hawkish” remarks from the Federal Reserve and the record highs for the S&P 500 and many other global indices. However, Wednesday’s price action teaches us all a good lesson – the US/China trade war won’t be over until both sides sign a trade deal. 

US/China trade war – it ain’t over ‘till it’s over

More than five weeks ago President Trump suggested that a ‘phase 1’ trade deal would be complete in a matter of weeks. Markets may have rushed to price in the good news, however, that deal is nowhere to be seen. Instead the pressure seems to be building: China has said that it wants further tariff rollbacks before it will sign a deal, and the US remains concerned about intellectual property rights. Even politics is playing a part. On Tuesday evening the US Senate passed a bill that condemned the crackdown on protestors and promised to support Hong Kong. This immediately drew ire from China, who, in retaliation, may now consider blocking attempts at a trade deal. China has a history of using its economic might to punish any country that it believes interferes with its affairs. With the eyes of the world on Hong Kong, and the eyes of the financial markets on a US/China trade deal, could the former now be a major stumbling block for the latter, and will China force the US into a corner over its support for Hong Kong? If so, then this would be a major heightening of trade tensions, that would make signing a trade deal very unlikely in the near to medium term. 

US/China trade war: all eyes on 15th December 

It appears unlikely that we will get a US/China trade deal next month and Reuters is reporting that the first phase may not now be complete until 2020. Since the spectre of a trade war between the two countries has been a major factor weighing on global growth, if the outcome remains uncertain as we move into next year, then we could see growth forecasts slashed for 2020 and the prospect of another rate cut from the Fed pushed forward (currently the market is pricing in another Fed rate cut in mid-2020 at the earliest.) The next date to watch for is December 15th. This is when the US is scheduled to increase tariffs on more than $150bn of Chinese imports of consumer goods, just ahead of the Christmas season. If this goes ahead then one can assume that a trade deal is unlikely to happen, and stock markets could see their traditional Santa rally cut short. 

Why the S&P 500 sell off could be short-lived 

Today’s news has weighed heavily on US markets, which had their biggest one day fall in 6-weeks, and volatility spiked. However, there has been some recovery in the S&P 500 as the US markets closed. The index dropped 30 points on the news about the trade deal to 3,090, however, at the time of writing it has moved back above 3,100 to near 3,110. Readers of our analysis will know that we have been upbeat about US stocks in recent weeks and we believe that we could see above 3,250 by the year’s end. However, the US/China trade deal, or lack thereof, remains a big risk to US and global stocks in the next few weeks. Tonight’s price action suggests that traders are happy to buy the S&P 500 on any dips, especially since most escalations in the trade war tend to be short term, with both sides quickly pledging to work together to find a deal. Anyone who is long the S&P 500 better hope that a resolution is found quickly. If the US does implement the next round of trade tariffs on Chinese goods on 15th Dec, then the S&P 500 could struggle to sustain its current rally into the year’s end. 

Boris fails to knock Corbyn out of first debate, pound struggles 

Elsewhere, the pound fell back from the $1.2980 highs from Monday to $1.2890 on Wednesday morning, after the first leaders’ debate in the lead up to next month’s general election delivered no clear winner. The Conservatives still have a comfortable lead, according to the latest YouGov polls, however, its support has dropped by 2% to 40%, with Labour up 2% to 30%. Since the Conservatives are considered a more market-friendly outcome from this election, the pound is swayed by the fortunes of the Conservative party. This recent shift is not a big enough to weigh on the pound in a substantial way, however, the fact that the Prime Minister could not land a killer blow on the opposition leader has worried some in the FX market. On the positive side for pound bulls, GBP/USD has reclaimed the $1.29 handle, and may attempt to re-test the $1.2950 highs from Tuesday. The dollar index is now in retreat after seeing some upward movement earlier on Wednesday, which could give the pound a chance to gain further ground back from the dollar as we move into the second half of the week. 

Looking ahead, the latest news from the US/China trade war is likely to be the biggest driver of markets in the coming days. Any sign that the relationship between the US and China is continuing to deteriorate will dim the prospect of a trade deal and likely weigh on risky assets. We would also point out that risky assets could continue to rise if tensions cool down in the coming days.