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MCF Weekly Capital Market Review - August 5th, 2019

As largely anticipated, on Wednesday the Fed cited muted inflation pressures and global developments (weaker global growth and bubbling trade disputes) as reasons to cut interest rates 0.25%.[1] The rest of the release paints a pretty rosy picture of the US economy with strong labor markets and moderate economic growth. So why cut rates? Under Greenspan, The Fed responded similarly in 1995-1996 and in 1998, with what now is known as an “insurance” cut.[2] An insurance cut is used as a cushion to protect the economy against potential weakness, rather than the traditional view of responding to real economic weakness. 

Fed Chair Powell appeared to communicate the concept of an insurance cut, noting in the press conference that the cut is a “midcycle adjustment” and not the beginning of a series of rate cuts. A rate-cutting cycle would be in response to “real economic weakness,” explicitly responding, “that’s not what we’re seeing.” [3] Market participants, however, expect multiple rate cuts, not just one. Markets currently are pricing in three more cuts within the next 12 months.[4] 

Hints of deteriorating US-China trade negotiations resurfaced when Trump took to social media on Tuesday to state that “China is doing very badly” and alleged that China is backing out again by not purchasing US agricultural products.[5] This comment quietly slipped past market participants, with the focus instead on other politically-motivated jabs. The renegotiation of trade deals was a prominent 2016 campaign promise that Trump has shown every intention of fulfilling, now even more so with the approaching 2020 election.

His comments on Tuesday have substance: China’s second quarter GDP slowed to 6.2%[6] and 40% of Chinese companies that provided guidance this year are forecasting a drop in earnings.[7]  China has goals of doubling 2010’s GDP and being a “moderately prosperous society” by 2021. These goals are explicit in China’s current 5-Year Plan[8] and implicit in President Xi’s highly publicized ethos of the “Chinese Dream.” China’s GDP must average 6.2% for the next two years in order to achieve these goals.[9] An escalating trade war with the largest trading partner is a clear economic obstacle.

Trump doubled down on Thursday, announcing a “small” 10% tariff on the remaining $300B of Chinese goods, effective September 1. This will be added on top of the prior $250B at the 25% rate. China’s total exports to the U.S. last year were approximately $550B.[10] Trump also singled out 

China’s failure to stop the sale of Fentanyl to the US as one of the reasons for the proposed tariffs. Although this announcement is negative, Trump balanced it out somewhat by stating talks were still constructive, referring to Xi as his friend, and saying that “the future between our two countries will be a very bright one!”

Trade negotiations will likely grab headlines through end of year. Treasury Secretary Mnuchin and his team continue negotiations with China and later this week with Japan. At the G7 summit August 24-26 in France, Trump’s discussions will likely involve the new French tax of 3% on all digital revenues and his response of proposing tariffs on French wine.[1] Trump could even hamstring the World Trade Organization by blocking new judge appointments in December, leaving the body unable to issue appellate decisions.

Equity markets were little surprised by the Fed decision, dropping a little then bouncing back the next day. But they quickly fell and trended downward in response to this new escalation in trade, with emerging markets hit the hardest. The 10-year Treasury yield fell to 1.86% by the end of the week,[2] pushing the widely watched 2-year and 10-year spread closer to inversion. Concerns of a coming slowdown due to further trade tensions pushed oil down almost 8% to below $54 and gold shot up to a 6-year high at $1,450 on Thursday.[3]

Corporate earnings continued to be mixed-to-positive but were overshadowed by the Fed and trade tensions. Indicators last week point to stable consumer spending and employment growth, muted inflation, and muted wage pressures. Consumer confidence roared back well above expectations. Mortgage applications and the Case-Shiller Home Price Index reflect a cooling housing market after large gains for the first half of the year.

This week should be quiet on indicators with reports on ISM non-manufacturing index, PPI, JOLTs, and jobless claims. More important will be next steps from both the US and China in the trade tug of war.


[4] CME FedWatch Tool

[10] https://ustr.gov/countries-regions/china-mongolia-taiwan/peoples-republic-china


Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by MCF), or any non-investment related content, made reference to directly or indirectly in this newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this newsletter serves as the receipt of, or as a substitute for, personalized investment advice from MCF.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  MCF is neither a law firm nor a certified public accounting firm and no portion of the newsletter content should be construed as legal or accounting advice.  A copy of the MCF’s current written disclosure statement discussing our advisory services and fees is available upon request. If you are an MCF client, please remember to contact MCF, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services. Please click here to review our full disclosure.


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