Trade Peace, Johnson’s Brexit, & a Fed Pause
Christmas came early last week with a number of major macro wins for financial markets. A “phase one” deal was announced on Friday; House Democrats and the White House reached a deal on USMCA; Boris Johnson’s conservative party won a major victory in the United Kingdom’s (UK) elections, marking a major step forward in negotiating the UK’s exit from the EU; and the Fed remained accommodative. Despite the slew of positive headlines, equity markets remained flat on Friday, surprising market commentators. Considering the S&P 500 is up 29% year-to-date, Friday’s benign trading activity was not surprising. As we look to 2020, we continue to recommend tempering expectations for forward equity returns, even though the fundamental story in the United States remains strong.
As we entered last week, all eyes were on December 15th – the day a tranche of tariffs on Chinese goods was set to go into effect. The expectation going in was for these tariffs to be postponed, setting up for a “phase one” deal early next year which will roll back some of the existing tariffs. The deal we got on Friday, although lacking on detail, surprised to the upside and arrived earlier than anticipated. The United States will cancel the existing October 15th and December 15th tariff threats, and reduce the September 1st tariff rate by 50% (from 15% on $125bn to 7.5%). That leaves the 25% tariff on $250 billion of Chinese goods for now. China will increase purchases of agricultural products, although the actual amount remains unclear. According to U.S. officials, China’s agricultural purchases could grow to $40 billion per year, with the president suggesting even as high as $50 billion. We are skeptical, considering this will be more than double the amount of Chinese agricultural purchases before the trade war began in 2017. At this time, the formal signing of the “phase one” deal is expected in January 2020, effective 30 days later (in February 2020). According to media reports, talks for “phase two” are scheduled to begin immediately.
As we reflect on what the “phase one” deal actually means for fundamentals, there is still a lot of uncertainty, making the impact on underlying earnings growth difficult to deduce. What did China give up exactly? – Vague intellectual property protections, a commitment to “not manipulate its currency,” and improving access to its financial services industry – which are all things they are already doing to some extent, and lack a lot of detail. Although the news is positive for sentiment, it is difficult to see CEOs and CFOs actually revising their capital spending plans and supply chain investments to take advantage of the change. Assuming tariffs/trade policy remain a key part of the administration’s foreign policy tool kit, the next several months will remain volatile.
In the same week, House Democrats and the White House struck a deal on USMCA (revised NAFTA), with the bill expected to make its way through Congress early this week. In the Republican controlled senate, an approved bill should easily get to the president’s desk by the end of this week. Even if the changes to NAFTA are cosmetic, passing USMCA removes a key overhang from financial markets and provides talking points for the campaign trail.
The Federal Open Market Committee also confirmed a pause to the easing cycle as they left rates unchanged at 1.50-1.75% (as expected), in the first unanimous vote since May. At this time, expectations show no change for all of 2020. Since the market is still pricing a one-third chance of a cut as soon as June, implying no changes to interest rates may be a mild surprise next year. At Haverford, we do not anticipate further easing from these levels, especially with the trade landscape improving and macroeconomic data stable. In addition, especially with last week’s inflation numbers (with CPI up 2.1% for the trailing 12-month period) remaining considerably benign, the Fed’s decision is appropriate and they can remain accommodative for the foreseeable future.
The Week Ahead
This week will be relatively quiet compared to last week. We will see December Flash Purchasing Managers Index globally (Japan, United States, EU, UK, and Australia), a second look at Gross Domestic Product in the United States, and a number of central banks will be holding their policy setting meetings.