• August was atypically volatile for global financial markets in response to escalated U.S./China tensions
  • The Fed is expected to cut the fed funds rate again in September, Powell and his colleagues have been hesitant to suggest a new easing cycle has begun
  • Looking ahead, markets remain most sensitive to U.S./China headlines, but the looming Brexit deadline also has the attention of investors

August is typically a sleepy month in the capital markets. Many participants are focused more on summer vacation and prepping for the final stretch of the year. However, this August was anything but sleepy. The fireworks kickstarted the first day of the month, sparked by a reliable and consistent source of market volatility in recent months/years – a tweet from President Trump. Beginning September 1, according to the president’s announcement, the U.S. would impose a 10% tariff on the remaining $300 billion of goods imported from China. The move was totally unexpected by the markets and came less than 24 hours after the FOMC announced a “mid-cycle adjustment” to the fed funds rate of 25 basis points (bps). A significant risk-off trade ensued, with Treasury yields falling 10-15 bps across the curve and equity prices sharply lower.

Not surprisingly, the timing of the tweet sparked speculation that Trump’s decision was the direct result of his disappointment in the Fed’s actions and forward guidance (i.e., not dovish enough). This is pure conjecture, of course, but there is very little certainty or confidence with regards to the trajectory of current U.S./China negotiations from a market perspective. There was short-lived relief for risk markets earlier in the month when President Trump announced that some of the $300 billion worth of goods would be temporarily exempted from tariffs during the holiday shopping season in order to provide relief for U.S. shoppers. The latter would seem inconsistent with the White House’s adamant stance that only China is impacted by tariffs, which has been strongly rebuked by many economists. Trade tensions were ratcheted up again on August 23 when China announced retaliatory measures to the new U.S. tariffs, including the resumption of a 25% duty on all U.S. cars sold in China beginning December 15. The retaliation further reinforced market expectations that China was willing to “dig in” following media reports that the White House was concerned about the trajectory of the U.S. economy ahead of the 2020 election, something that Chinese leaders don’t have to worry about. President Trump was quick to respond, announcing later in the day that the U.S. would be increasing both current and upcoming tariffs, typifying the tit-for-tat escalation of trade tensions that has worried market participants for more than a year.

Markets are keenly aware that these tensions could end quickly with a comprehensive trade agreement, which appeared to be close to fruition in the second quarter. However, the unknown at this point is whether significant damage has already been done. Business sentiment/investment has weakened, and global growth has already been negatively impacted by tariffs. The general expectation is that slower growth abroad will eventually make it to our shores given the interconnectivity of the global economy. Regarding the White House’s focus on China, there is relatively broad support among market participants and economists for taking a firm stance against the Chinese government’s unfair practices toward foreign firms, particularly on the technology front. Intellectual property theft and forced technology transfer has been an issue across multiple U.S. presidential administrations, but there is less support for the White House’s current approach to this trade “war.” If tariffs are being used as a means of forcing the Chinese to accept and abide by reforms to unfair trade and business practices, markets may be more understanding. However, if the tariffs are just about trade protectionism and eliminating the trade deficit, investor anxiety and growth concerns will continue to rise. There are plenty of historical examples of the negative consequences of such actions, most notably the 1930s. In the end, markets respond negatively to uncertainty, and the recent trade decisions from both sides have fueled more doubt.

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