Hope and Fear

For investors, the year began in fear. The global economic slowdown, the yield curve, Fed policy, trade policy, and the partial government shutdown generated risk. Last week, the news was mixed. There is no sign that the budget stalemate in Washington will end soon. There were renewed reports that President Trump is considering imposing tariffs on all imported motor vehicles. The University of Michigan’s Consumer Sentiment Index fell in the mid-January reading. Yet, there were also reports that the Chinese are willing to make concessions, paving the way for possible progress in upcoming trade talks. The fact that the stock market was willing to ignore the bad news and embrace the good seems to tell us something.

Fear can create fear. In a stock market downturn, investors sell because other investors are selling. The stock market’s march higher into the summer of 2018 was associated with an unusually high level of complacency (and an unusually low level of volatility). However, a list of concerns were growing, and by October became more meaningful. Panic levels remained high in the first few trading sessions of the new year, before Fed Chairman Powell signaled a flexibility on monetary policy and the central bank’s unwinding of its balance sheet. Most economists were nonplussed about what Powell said. Of course, the Fed is flexible. That goes without saying. Powell had already signaled in his post-FOMC press conference that the Fed could be patient in raising rates in 2019. Powell’s comments were self-evident, but they appear to have acted as a slap in the face for the financial markets.

Scott Brown
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Two of the biggest risks to the economic outlook have been self-inflicted: trade policy and the budget stalemate. The economic impact of both start out relatively modest, but build over time. Both are unnecessary.

Neither side wins in a trade war. Tariffs are a tax paid by U.S. consumers and businesses, not the other country. Tariffs are not necessary to force the other side to the table. There are much better ways. Many had expected the trade conflict with China to end quickly. The trade agreement with South Korea seemed a likely blueprint: make some minor adjustments, declare victory, and move on. This is in effect what happened with the dispute with Canada and Mexico. The U.S. Mexico Canada Agreement is essentially NAFTA with some adjustments in the content requirements in motor vehicles. The disagreement with China has been a different story. For much of the conflict, Chinese negotiators complained that they were unsure of what the U.S. wanted. Indeed, Treasury Secretary Mnuchin, U.S. Trade Representative Robert Lighthizer, and White House National Trade Council Peter Navarro had conflicting approaches (this is reported to be consistent with President Trump’s business strategy of pining subordinates against each other), often in public view. More recently, Lighthizer has emerged as the point person on trade negotiations. That’s a step forward. The threat of an expansion of tariffs on Chinese goods has been disruptive. It’s likely that many firms have stockpiled inventories of raw materials and supplies, although we don’t know because the government shutdown has delayed the release of foreign trade and inventory data. A settlement in the U.S.-China trade dispute would be taken well by investors, and stock market participants appear to be pricing in a favorable outcome.