Stocks staged a sharp rally yesterday after President Trump tweeted that he would have an extended meeting with Chinese President Xi at the upcoming G-20 summit and that trade talks with China are resuming. The move came in front of today’s conclusion of a two-day FOMC meeting. Results will be released early afternoon with a press conference led by Fed Chairman Jerome Powell to follow.
We and others have been highlighting that the two binary events that can move markets over the short term are the success or lack thereof of trade negotiations with China and the path of future rate decisions from the Federal Reserve. With the market now back within a percentage point of all-time highs, markets have spoken quite clearly that they now expect a favorable outcome from both events. The Fed may not lower rates today; the markets put the odds of that happening at about 20-25%. But markets do expect a strong signal that rates will likely be cut either in July or September unless there is a significant increase in the rate of inflation. If rates are, in fact, cut today, the market will almost certainly extend yesterday’s rally in a meaningful way, presuming that the Fed doesn’t overplay its hand and show serious concern that the economy is in danger of rolling over into recession. I seriously doubt Mr. Powell would even hint at that.
On the other hand, even though consensus says rates will be held steady but that a dovish statement would set the table for a rate cut as soon as the end of July, I am not so sure that markets would react positively to that outcome unless Mr. Powell was very emphatic calling for a July rate cut presuming no serious change in the data flow between now and then. One could easily argue if a July rate cut was already baked in, why not simply do it now? Does anyone really believe inflation is going to change suddenly in 6 weeks? Certainly, the President would like to see a cut now. In fact, suggestions are already circulating that if the Fed doesn’t cut rates tomorrow, Mr. Trump might try and replace Mr. Powell as Fed Chair but leave him on the Board. Markets certainly would not like that outcome. Even if you accept the conclusion that the Fed hiked rates once or twice too often last year, markets want to see the Fed remain independent. They don’t want politicians dictating or influence monetary policy.
As for trade talks, Mr. Trump has proven adept in rattling sabers and then backing away in a way that has kept investor optimism (and the bull market) in tact. Last night he started his formal campaign for reelection. Mr. Trump knows that an S&P well over 3000 will be a better stage to run on for reelection than an S&P well below 2500. While he can’t fabricate economic growth single handedly, taking a less aggressive stance on tariffs and pushing for lower interest rates are two steps that will be highly stimulative to markets.
But with that said, after yesterday’s rally, an awful lot of good news is now priced in. Markets once again believe that a tariff war with China has peaked. There may not be a formal agreement at the G-20 meeting, but one is probably not so far away. At least that is today’s consensus. As for interest rates, it seems only a question of when the Fed will lower rates, not if. The problem is that the market now leaves little room for disappointment. The last summit with North Korean Leader Kim Jong Un was unsuccessful, to be polite. Iran tensions are rising and while neither side wants conflict, neither side is in a rush to back down either. The risks that one side or the other might step over the line are rising. Trade talks with China simply might not find the necessary common ground to satisfy Trump or his supporters.
Remember that I described today’s FOMC meeting and the G-20 summit as binary events. Either the Fed lowers rates (a big plus for markets) or it doesn’t. Even if Mr. Powell sounds very dovish at the post-meeting press conference, there is nothing he can say to guarantee a rate cut in July. As noted earlier, if July were a certainty, why not just do it now? As for the meeting with Trump and Xi, while both respect each other, they have conflicting agendas, conflicting forms of government, conflicting time horizons, and conflicting strategies. Trump could be tempted to sign something that gives lip service to problems like intellectual property theft but the whole world would quickly see through a paper tiger agreement. Thus, if he doesn’t get what he wants, there is a real chance that he comes home empty-handed and elevates tariffs. Markets are clearly not ready for that.
After today’s meeting, one of the two binary events will be history. We will know pretty clearly where the Fed stands and markets will make a very quick adjustment. It will be another week plus before we know what the G-20 might bring. While the air of optimism pervades today, that could quickly change over the next 10 days. I, for one, am not going to be a hero, particularly with markets rather fully priced. In the end, earnings matter and we will see second quarter results shortly beginning in mid-July. Until then, the Fed and China are the focus. After those events, however, markets will remind us that earnings matter.
Today, Boris Johnson is 55. Paula Abdul turns 57. Kathleen Turner is 65.
James M. Meyer, CFA 610-260-2220