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Market Update - Far from a summer lull

13th August, 2019

At a time of the year when holiday makers are typically arranging their sun loungers at the poolside, financial markets have been behaving in a manner far from their typical summer lull. The past few weeks have provided no shortage of market-sensitive headlines and announcements, below we attempt to provide a brief summary of recent activity and the impact it has been having on financial markets.

Trump’s trade policies force Powell’s hand

On Wednesday, 31st July, Federal Reserve (Fed) Chairman, Jerome Powell, announced the first interest rate cut since the financial crisis in 2008. The cut was implemented despite the US economy continuing to grow at a "healthy pace" and an unemployment rate that continues to hover near its lowest level since the 1960s.

The recent data confirms our view that the rate cut was precautionary in response to ‘uncertainties’ and global economic weakness, rather than a recessionary cut that we witnessed in 2000 and 2007. The market has now fully priced another rate cut in September and another 100bps of cuts over the next twelve months. As the Fed looks set to continue the trend of acting as a buffer from potential shocks in order "to sustain the expansion", they are taking a step away from their dual mandate of achieving both stable prices and maximum sustainable employment.

Expect the unexpected

On Thursday, August 1st, President Trump blamed setbacks in trade talks as he announced plans to impose a new 10% tariff on the remaining $300bn worth of Chinese imports. This move astonished investors as earlier indications had been that US and China representatives had come to a constructive discussion, albeit with no tangible proposals. With the current tariff rate said to have the potential to go “well beyond 25%”, Trump retained leverage for future trade negotiations.

China responded with Yuan devaluation and the halting of purchases of US agricultural products, a retaliation which was measured at “11” on a scale of 1-10 by some market participants. Fortunately, China re-boosted the Yuan the following day, inspiring a softer tone from the US administration, with the White House economic adviser, Larry Kudlow saying that Trump is flexible on China trade tariffs and that the Chinese delegation are expected to travel to the US in September for further discussions.

Sterling pricing a higher probability of a no-deal Brexit

Adding to the headlines on Thursday, 1st August, sterling fell to its lowest level versus the US dollar in two and a half years, as the probability of a no-deal Brexit increased further. Investor’s complacency of a no-deal not occurring is gradually evaporating. Last week, Johnson added to his recent rhetoric informing the European Union that talks on reaching a new Brexit deal will not commence until the previously rejected divorce agreement is reopened – something that the EU has stated it has no intention of doing.

Several obstacles remain for Johnson, If no amendments are agreed with the EU Members of Parliament (MPs) may attempt to legally oblige the government to request a further extension to avoid leaving without a deal, alternatively, a vote of no confidence may take place. It is likely that sterling will experience further bouts of weakness if both sides remain at loggerheads as the 31st October gets even closer.

Losin’ it

Until last week, there had been a “greed and fear” clash in the market, as equity valuations had reflected an optimistic outlook while US treasuries yields had signalled a recession. Last week, Trump’s tariff shock coupled with some disappointment from 25bps vs 50bps rate cut triggered a deterioration in investor sentiment and subsequent weakness in equity markets across the US, Asia, and Europe.

China’s warning that it was ready to launch a currency war exacerbated these worries and the stocks got hammered, while a rally in Treasuries emphasised that the risk of a recession has increased. Both sides later softened their approach, which provided some relief for the markets, but the uncertainty in relation to trade conflict remained. There many reasons for volatility and noise to remain in the market as trade talks resume in September, the Brexit deadline approaches in October, and Trump’s postponement in implementing auto tariffs (which are critical to the European economy) is set to expire in November.

What next…?

We expect volatility and noise to continue to feature over the next six months in the run up to the US Presidential primaries in February 2020 and the fear of a no-deal Brexit prevailing.  As we get closer to the election date in November 2020, it is likely that Trump induced volatility will diminish as a healthy US economy and a strong market will be fundamental to his success. Just when market participants lost all hope, on the 13th of August, the Trump administration u-turned and announced a delay to the 10% tariffs on some Chinese exports until December. As per above, expect the unexpected...

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