For those of you who would prefer to listen:
The Market churned this week, with a lot to digest from the FED to trade talks, we will jump right in. The de-escalation of the trade wars has been the big driver of stocks. It’s been pretty clear; The Market has been at the mercy of the constant contradiction in trade headlines. Investors have been jerked around by the price action.
Before I get deeper into trade, I will start with the Fed. For, America’s Central Bank still matters. What they do with monetary policy impacts all things financial. The Fed met this week. No action was expected. No action happened. But there were important words said.
The overnight rate that banks borrow from each other held steady at the 4.25-4.50%range. The chances of a rate cut in June just shrank. The Market is assigning just a 17% probability of the Fed cutting at their next meeting. It was 55% a week ago. Heading into the meeting, the Market was pricing in 3 Fed rate cuts this year. That was down from 4 cuts, totaling a full 1% decrease, expected prior to the better-than-expected April job report, released last week.
The Fed takeaways revolve around “waiting” and “uncertainty”. Those are not action words. Of course, the Fed has its dual mandate: Maximum employment and stable prices. Both are feeling pressures. Risks of higher unemployment and higher inflation have both risen.There is an ongoing debate as to which side of the mandate is more pressing. Cutting rates could spike inflation, at a time where prices are already rising due to the tariffs. By not cutting, there is a risk that the economic slowdown accelerates. The biggest risk is for both to happen simultaneously, slowing growth and rising prices. It has a word. It’s not a good one. It’s “stagflation”.
The Street is hugely divided on the subject. In fact, some on the Street are modeling the first cut to come in December or no cut at all in 2025. Goldman Sachs said hard data is taking longer to deteriorate, but still expects 3 cuts this year. On the extreme side, Citi predicts 5 rate cuts on an expected surge in the unemployment rate leading to recession. You can see the uncertainty weighing on these estimates. From no cuts to 5 cuts, the Market is gyrating around the mean.
Fed Chair Powell asserted that with such levels of uncertainty, the Fed can afford to be patient. The Fed Chair was coy on a possible June cut. The Market now sees it as a high bar. Nobody knows where tariffs will be on July 9th. That’s the day after the 90-day pause is set to expire. Why would the Fed move before the tariffs pause ends on July 8? To that end, it’s no surprise that stocks and bonds proved far more sensitive to the latest headlines on trade than to the Fed.
Both Earnings Season and recent economic data show that despite some clear slowing, America’s Economy keeps chugging along. That froze the Fed. So far, the tariff threat triggered purchases brought forward, so there is minimal hard data to gauge the eventual impact on employment and inflation. The issue doesn’t seem to be recession. As one of our partners phrased it, the real issue is suppression. It’s manmade. The extremities of trade policies have forced companies, countries, investors and fellow citizens scrambling with uncertainty as to what lies ahead.
The big news on trade this week was a deal with the UK. Was it a full and comprehensive deal? It doesn’t appear to be. The optics say no. The Trump administration agreed to roll back tariffs imposed on British steel and cars in exchange for purchasing Boeing jets while also expanding access for American farmers to British markets. However, the 10% baseline tariff rate still stands. Goldman Sachs concluded the new dealwould reduce the US effective tariff rate by less than 0.1%. It barely moved the needle.
Both sides needed a win. This deal fits with broader but volatile de-escalation theme that has been the big driver of the recovery rally. Importantly, we run a trade surplus with Great Britain. That means we sell more to the United Kingdom than they sell to us. A deal has been struck. Both sides are calling it a big win. Perhaps most significant is simply the dual announcement itself. The UK was first out of the gate which apparently the British wanted. Remember, they’re no longer part of the EU. The British sorely need trade wins too. They definitely need the US on their side. The reverse is true too.
Perhaps this milestone will trigger some momentum. The White House has indicated deals with Japan, India and South Korea are close. Of course, we all know that what matters most to the World and the Market is what happens with China. Stocks got a boost midweek with the announcement that a high-level meeting will take place this weekend in Switzerland. Treasury Secretary Bessent will meet with China’s Vice Premier. The talks will reportedly focus on de-escalation rather than any sweeping deal. The Treasury Secretary reiterated the US is not pushing for decoupling and just wants fair trade. President Trump said he’s unwilling to dial back the existing 145% tariffs on China. That was Wednesday. On Thursday he said they’re coming down. The inconsistencies have caused the chaotic price action.
China has been stern in its response all along. Both sides have been playing hardball. However, it’s been reported that China has been driven to the negotiating table amid concerns about the economic pain from the tariffs and risk of isolationas other key trading partners like Vietnam, India and Japan have quickly engaged in talks with Washington about finding agreements. Somewhat telling, neither Presidents Trump nor Xi will be present in Geneva. That speaks to the infancy of these negotiations. But significant for so many other reasons, this week the Chinese President was in Moscow with Vladimir Putin, demonstrating loyalty and strong support for Russia.
The AI trade has come back on in May. This week, the White House announced it is planning to rescind the AI chip curbs from the Biden administration. The Trump administration plans to rewrite policy that they believe would strengthen the control of chips abroad. It seems as though it is designed to eliminate the tiered system which could be used as a negotiating tool in trade talks. The timing of the announcement was intentional. It came just before the President’s Middle East trip. Saudi Arabia and the UAE, key trading partners, have complained about the ability to acquire AI chips. The significance of the President’s first scheduled foreign trip being the Middle East shouldn’t be lost either.
The Biden administration aimed to prevent China from acquiring AI chip technology via intermediaries. It’s been reported that China has been able to bypass the restrictions with shipments going through Malaysia and Singapore. The Trump administration called the rules ineffective and overly complex. The new administration asserts it will continue with the commitment of strict enforcement of semiconductor and GPU export curbs while it develops new guidelines. The White House will also impose chip controls on those countries that have diverted chips to China.
Silicon Valley leaders like Nvidia and AMD have been lobbying for a repeal of AI diffusion rule. Nvidia Founder and CEO Jensen Huang has asserted that American companies should be able to sell into China, calling it a $50 Billion market for AI chips in the coming years. Huang has made it clear that our national security comes first, but some Federal policies are overly onerous. There’s a balancing act here. One thing is clear: It’s absolutely essential, economically, geopolitically and militarily that the United States maintains its leading dominance in Artificial Intelligence.
Outside of the tariff threats, inflationary pressures have been subsiding. Much of it has come from the price of Oil. It has collapsed to its lowest level since early in 2021. That was back during Covid. Lower Oil prices directly put downward pressures on inflation. It impacts the cost of fuel, power and manufacturing, among others. That’s a good thing for we consumers. But we also have to ask why the price of Oil has fallen. The simplicity of supply and demand is involved. Demand is clearly slowing as the Economy shows signs of stalling. On top of this, supplies are increasing as OPEC+ has recently raised production.
Cheaper Oil isn’t necessarily a total boon. It reduces input prices for industrialists who might be facing a tariff bill for importing components. That’s a good thing. But it also eats into the incentive for American Energy companies to increase production. OPEC+ has been frustrated with America’s Energy renaissance, essentially achieving independence. Plus, OPEC+ cheats. Not all members have been cutting back on production in hopes to keep prices higher. Now that the price of Oil has collapsed, they’re flooding supplies in attempts to increase sorely needed revenues while simultaneously bleed US production. With the price of Oil below $60, profitability gets squeezed. American Energy companies are likely to cut back their production until the price stabilizes and climbs back towards $70. Unlike the Stock Market, the price of Oil has not recovered to pre-obliteration day levels. What’s the solution here? Well, remember the old adage, the cure for low prices is low prices.
Back to the Market:
Since the creation of the S&P 500 in 1957 there had been 14 declines of 20% or greater. The crash in April made it 15. One of our independent research providers did a comprehensive study. It found that once a 20%+ decline had retraced 50% of its losses from the lows, breaking down to new lows occurred just twice. It’s proven to be a rarity. The Bear Markets in 2022 and 2008 were the exceptions to the rule. You may recall, 2022 was a grind. We sure remember it. And of course, 2008 was a financial crisis. I’ll never forget that period for the rest of my life.
So, what does that mean for today? Well, we survived that brutal 20% S&P crash last month. That’s big. And equally big has been the 14% rally off the April lows which erased 60% of those losses. With history as a guide, it suggests that normal back and filling is expected but a high likelihood that the lows are in for this cycle. A sample size of 14 is not necessarily large, but it’s not insignificant either. Of course, there is nothing normal about today. The worst may be behind us from a Market standpoint. But the worst is likely still ahead of us economically. The current economic environment does not appear to be in immediate risk of recession. The Market crash was caused by an economic suppression.
An economic suppression can change quickly compared to a recession caused by natural business-cycle drivers. In this environment, headlines are more impactful than data. It can be unpredictable. It can be chaotic. It certainly is volatile. The Market has been sniffing out the desires for off-ramps from the trade wars. It’s clear that nobody has been winning. The deal with the UK symbolized the new goal. The big issue will begin to be addressed in Geneva this weekend. China and the United States are the largest economic powers, and number three is not even close. The Market seems to be pricing in a positive outcome, even though no deal is expected. We will be following developments closely. We continue to proceed with caution but do find comfort in the recent price action. Keep those belts buckled.
If you prefer to listen to these pieces rather than read my long prose, we have engaged my new AI partner who allegedly sounds just like me. Or is it me? You be the judge. Thanks for reading and/or listening. I hope you enjoy these weekly pieces. There’s certainly no shortage of material to cover.
Happy Mother’s Day, to my mom, my bride and all you beautiful mothers out there!
Have a nice weekend. We’ll be back, dark and early on Monday.
Mike
