Fears of a Trade War Ending? What About the Fed?

The market effects of the trade war may be about to reverse.  With negotiations between the US and Canada/Mexico scheduled for early this week and China later in the week, headlines are likely to turn hopeful for an end to the trade wars.  Moreover, any weakness in US manufacturing data may very well have just a fleeting effect on the markets, as it is seen as tariff-induced and temporary.

Stocks should be helped by an abatement of trade war fears, although the boost could be tempered in this seasonally soft period for the market.  In contrast, the dollar has likely peaked.  As I've been arguing, somewhat counter-consensus, the imposition of tariffs by the US caused the dollar to appreciate on the expectation of a future narrowing in the trade deficit.  Conversely, eliminating the tariffs should lower the dollar.  A weaker dollar and an ending of the fears of a trade-induced slowdown in the US economy point to higher Treasury yields. 

The markets' focus will shift back to the Fed this week -- the minutes of the July meeting will be released on Wednesday and Powell will speak on "Monetary Policy in a Changing Economy" at the Jackson Hole Conference on Friday.  Neither will likely increase the odds of a pullback from the Fed's path of gradual tightening.  It is too early to say with any certainty whether economic growth is slowing appreciably because of the trade war turmoil.  And, any negative impact from the tariffs could reverse quickly if, as is likely, the trade disputes get resolved.  Meanwhile, inflation remains in check and near the Fed's target.  Importantly, last Friday's release of the University of Michigan Consumer Sentiment Survey showed little change in long-run inflation expectations, displaying no significant impact from the tariffs that have been applied so far.


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