Tariff Announcement - Volatile Thursday
With a major Tariff Announcement - Thursday was one of the most interesting days of 2019 for markets. Stocks rallied on bad economic news and then sold off. Mostly because President Trump issued a new tariff on China.
Right after the Fed was hawkish, the market immediately went back to expecting more rate cuts. Mostly due to the weak manufacturing PMIs and the weak construction spending report. That’s somewhat illogical because the PMIs were only slightly weaker than estimates.
Plus, the Challenger Job Cut report showed a decline in job cuts which is good news. The market really wanted rate cuts, so it decided to price them in.
Fed has lost control of the Fed funds futures market.
Tariff Announcement - Regardless of whether the Fed really is about to cut rates in September, if you take the newfound expectation of a cut at face value, it’s bullish for stocks. That explains why stocks initially reversed their losses from Wednesday.
The new Trump tariff threw a wrench into this situation and sent stocks back down. Trump’s tariffs are a better reason to expect rate cuts. The stock market reacted negatively to them because they will hurt the economy.
Apparently, moderately negative economic data is good news because it means rate cuts. But new tariffs hurt stocks because they mean more economic weakness.
It’s not entirely logical as the bad news events both portend bad things for the economy and greater odds for rate cuts. In defense of the market, the Trump tariffs were a big surprise which created uncertainty.
Tariff Announcement - Specifics Of Thursday’s Action
Stocks rallied in the morning and declined in the afternoon. Bad news helped stocks and then hurt stocks. The market moved towards expecting more rate cuts and stayed that way.
S&P 500 was up 1.09% as of 11:30 AM and closed down 0.9%. From the peak to the close, the market fell 1.99%. Tariff news a was a big deal. Nasdaq fell 0.79% and Russell 2000 fell 1.51%. The market expects more rate cuts. So the small banks fell and brought the Russell 2000 down with them. KBW regional bank ETF fell 4.17%.
VIX rose 10.86% to 17.87. It’s starting to price in real volatility. I would lean towards betting on less volatility if the VIX gets above 20 all else being equal. CNN fear and greed index fell 5 points to 43 which is fear.
That’s accurate as the market is now dealing with more weakness in manufacturing and more tariffs. A trade war could help catalyze a manufacturing recession in the 2nd half of this year.
Utilities rallied 1.02% because of the decline in treasury yields. And also because of the risk off nature of the action. Worst sectors were the financials, energy, and industrials which fell 2.32%, 2.28%, and 1.98%.
Big Treasuries Rally: Rate Cuts Coming Soon
Tariff Announcement - Treasuries rallied hard. The 10 year yield fell 12 basis points to 1.89%. It’s now at 1.88%. That’s the lowest yield since November 2016. The yield is starting to close in on its all time record low.
If the economy falls into a recession, it wouldn’t be shocking to see a zero handle on the 10 year yield. I don’t see a recession occurring soon though. 2 year yield fell 13 basis points to 1.74%. It’s back to being 14 basis points below the 10 year yield.
One hawkish Fed statement in August will cause the 10-2 curve to invert. 2 year yield doesn’t even need to get to 2% for an inversion. It might invert if the Fed cuts rates just one more time this year.
This rally is not new for bonds. As you can see from the chart below, the 3 month annualized returns of the JP Morgan global USD government bond index are the highest since 2009. Returns are in the 99th percentile.
The action in the Fed funds futures market is confusing
Tariff Announcement - Especially because the manufacturing PMIs weren’t that bad. I actually expected the ISM PMI to be worse than it was. Now that the President issued a new tariff, expecting a rate cut in September makes sense.
Maybe I shouldn’t quibble about how we got here. On July 31st, there was a 50.7% chance of a rate cut and now there is an 86.5% chance. At that percentage, a September cut is a guarantee.
Fed is boxed into a corner, because if it doesn’t guide for a cut, the stock market will crash further. With the latest tariff announcement, a September rate cut might actually be justified.
Tariff Announcement - Specifics Of President Trump’s New Tariff
Let’s delve into the details of the announcement. It was a surprise because it was thought that China and America were making progress in their negotiations.
Specifically, President Trump tweeted. “Recently, China agreed to buy agricultural product from the U.S. in large quantities, but did not do so. Additionally, my friend President Xi said that he would stop the sale of Fentanyl to the United States – this never happened, and many Americans continue to die! Trade talks are continuing, and during the talks the U.S. will start, on September 1st, putting a small additional Tariff of 10% on the remaining 300 Billion Dollars of goods and products coming from China into our Country.”
Now America is taxing all Chinese exports.
Tariff Announcement - President Trump’s next threat was to tax the $300 billion worth of goods at a 25% rate. I don’t think this situation is as bad as it looks. It doesn’t change my opinion that there will be a deal in the next few months.
In the short term, this obviously hurts the economy. This action shows President Trump will do whatever it takes to pressure China to make a deal. The time he has left is dwindling, so he needs to increase the steaks.
China now knows Trump will quickly increase tariffs if it doesn’t negotiate in good faith. Hopefully, the negotiations become more fruitful in the next few weeks. If they go well, the President can take away this new tariff before it is implemented.