ECONOMIC UPDATE

  • Trade worries contributed to increased market expectations of a Fed rate cut.
  • Three events during the week of June 17 eased investor concerns and boosted risk assets.
  • The FOMC did not cut rates at the June 19 meeting. However, updated forward guidance suggests more Fed leaders prefer multiple rate cuts in 2019, which is in line with current pricing in the fixed income market.

For much of Q1 and the first month of Q2, global financial markets were relatively tranquil. This was positive for risk assets. The domestic economic data trend was lagging expectations, but the general trajectory of the U.S. economy was still positive. Perhaps more importantly in the near-term, it appeared that U.S. and Chinese officials were closing in on a trade deal that would put the largest macro risk of the past year to rest. However, as Q2 progressed, disinflation concerns emerged, leading some Fed leaders to suggest that “insurance” rate cuts might be necessary in order to boost inflation expectations. Fed Chair Jerome Powell was somewhat dismissive of these concerns following the May 1 FOMC meeting, but a tweet from President Trump the following weekend changed everything from a market perspective. The president effectively accused the Chinese of reneging on the bulk of U.S. demands in the final stages of the negotiations. On the following Friday, the tariff rate on more than $200 billion of Chinese imports was raised to 25%. This was a sobering bucket of cold water for equities and other risk assets, and Treasuries rallied sharply.

The White House followed up with targeting measures against Chinese technology interests, including a potential ban on the sale of U.S. technology components to Chinese telecom giant Huawei. More negative trade headlines followed in the ensuing weeks, including threats of tariffs against Mexico in order to force greater cooperation from the Mexican government in curbing illegal immigration to the U.S. (essentially weaponizing trade). With risk sentiment snowballing, fixed income markets priced a greater probability of Fed rate cuts in 2019, with a July cut a high likelihood. In fact, prior to the June 19 meeting, fed funds futures were pricing for two rate cuts by year end. In the days that followed, futures implied approximately three cuts.

There were some positive signals for risk markets in June, particularly during the third week of the month. Three separate headlines/events captured the attention of investors:

  1. Tuesday 6/18: ECB President Mario Draghi’s speech
  2. Tuesday 6/18: President Trump tweets on China negotiations
  3. Wednesday 6/19: FOMC meeting

Beginning with European Central Bank (ECB) President Mario Draghi’s speech, the central bank head struck a sharply dovish tone. He said the central bank is prepared to initiate fresh rate cuts, and more importantly for markets, he suggested the ECB’s asset purchase program “still has considerable headroom.” Equity markets rallied on the comments and European bond yields hit new record lows. Reports also began to surface that Draghi’s comments caught other ECB leaders by surprise and inside sources suggested that there was certainly no consensus within the ECB Governing Council on the path ahead from a policy perspective. Nevertheless, Draghi was successful in planting the seeds for more easing, which was enough to spark a reaction from financial markets.

The second event of the week occurred within hours of Draghi’s June 18 speech. President Trump tweeted that he and Chinese President Xi had a “very good” phone call and that the two would have an “extended meeting” at the G-20 summit. At that point, investors were looking for any semblance of thawing in U.S./China tensions. Even a tweet from the president was enough to solicit hope. That said, the most realistic result from the Trump/Xi meeting in Japan would be a cease-fire and the resumption of good-faith negotiations. That’s effectively what happened when the two met on June 28. Following the meeting, Trump told reporters that he wouldn’t levy additional tariffs on China for the “time being” while the two countries resume negotiations and U.S. companies will again be allowed to sell supplies to Huawei. The Chinese telecom giant will remain on the Commerce Department’s blacklist, but the sale of American components for Huawei products is not deemed a threat to U.S. national security. The two sides still have a long way to go with negotiations. However, from a market perspective, this truce buys a little more time.

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