US equities are riding the best string of weekly gains in two years.
President Trump has something akin to full buy-in on the "Phase One" trade deal.
With the Fed keen to stay on hold (especially given the political environment), a "no deal" outcome is now an unthinkable proposition.
One of the things that makes it so enjoyable for me to spend my free time (which is all of my time) documenting every twist and turn in the evolving market narrative is that beginning about two years ago, the jokes started writing themselves.
On Friday, for example, equities surged primarily because Larry Kudlow, while speaking to reporters the previous evening, said the US and China are "coming down to the short strokes," and while a trade deal is "not done yet," it's "close."
That was at least in part responsible for the Dow pushing through 28,000, in what was the second best day of the month for US stocks.
Take a minute to bask in the hilarity of it: Larry's "short strokes" remark pushed the S&P into overbought territory for the first time since April, and helped the gauge to a sixth consecutive week of gains, the best run in two years.
But Kudlow didn't say anything new, and it's entirely likely that he only said what he did say because both the Wall Street Journal and the Financial Times had released somewhat downbeat accounts of the negotiations, which both outlets said had hit stumbling blocks on the path to the elusive "Phase One" trade deal.
That's not to suggest a deal isn't at hand. It's just to underscore the fact that to the extent Friday's risk-on mood was "informed" by Kudlow, that speaks to how overtly silly this situation has become. Even if you were inclined to take Larry seriously, it's worth remembering that Kudlow is not a "principal." That is, when you hear the administration mention "principal-level" trade talks, that's not Larry. He may be a party to those talks, but the principals are Liu He, Steve Mnuchin, and Bob Lighthizer.
Still, a rally's a rally, and a record high is a record high, so who are you and I to complain, right?
In the context of all this, there is one simple point I want to make for readers here over the weekend.
You should be aware that the market has, to a certain extent anyway, backed the Trump administration into a corner on the trade deal. In the past, President Trump has used equity rallies as an excuse to push the envelope with China on the apparent assumption that record highs give him a "cushion," so to speak.
That seems like an untenable strategy at the current juncture for a couple of simple reasons.
Previously, Trump had a somewhat plausible argument about the Fed having been too slow to shift to a neutral (and later to an overtly accommodative) policy stance. I use "plausible" very loosely there, but up through this summer, the President was generally free to engineer trade uncertainty, knowing that if doing so knocked equities off the highs, he (and his surrogates) could make a show of insisting that the Fed should cut rates.
Those exhortations were backed up by easing in other locales, by clear signs of economic deceleration abroad and also by Jerome Powell's desire to avoid a repeat of Q4 2018. In May, it seemed to occur to Trump that if he could succeed in using trade balderdash to push the rates market into pricing in aggressive Fed easing, he could effectively dictate monetary policy. That's because wrong-footing the rates market risks catalyzing a tightening of financial conditions, which would make policy easing necessary anyway.
That dynamic caused consternation among analysts, as it risked exacerbating a situation where both the economy and stocks got stuck in a loop. Recall the following illustration:
We're now somewhere between the purple and light green squares. But this time, stocks are in full-on, melt-up mode, and although the data has improved since August, there is no arguing that activity is as robust as it was in the earlier stages of the trade war.
The following is a bit of a "chart crime," and we all know the US economy doesn't live and die by the manufacturing sector, but when it comes to illustrating the point, I could scarcely think of a better visual than an overbought S&P plotted with ISM in contraction.
To be clear, I don't think President Trump wants to tempt fate, and I'd be willing to bet most readers here would agree with me. There is no scope for additional fiscal stimulus right now. Another tax cut package would be D.O.A. on Capitol Hill ahead of the election and besides, the ballooning budget deficit constrains fiscal policy, at least until there's more buy-in for the kind of "public-private" policy partnerships I discussed in "How The Machine Works."
The upshot: If another trade escalation were to undercut the economy anew and put us back where we were in August (when consumer sentiment dipped, ISM manufacturing first slid into contraction, and polls began to show Americans doubting the President's economic stewardship), there would be nothing the White House could do, short of backtracking swiftly on any tariff increases.
The Fed clearly indicated in October that the committee intends to remain on hold. Anything beyond the three cuts already on the books would cast considerable doubt on the characterization of the easing since July as a "mid-cycle adjustment." A fourth cut would make this a "real" easing cycle, and that isn't something policymakers are excited about embracing - especially not when two voters have stuck to their dissents.
True, the bar for more rate cuts is much lower than the bar for the resumption of rate hikes, but that doesn't mean the bar for more easing is low in an absolute sense.
Powell went out of his way to underscore the "good place" characterization of monetary policy during his remarks to lawmakers this week, even as President Trump dedicated a good portion of his address to the Economic Club of New York to lambasting the Fed and explicitly demanding negative rates. "Gimmie some of that money," the President said, in the course of asking Powell to take rates negative. "I want some of that money."
In the past, the Fed hasn't been shy about moving rates in election years, but I don't think it's a stretch to say that 2020 is "different." There is probably no appetite at the Fed for aggressive moves in either direction next year unless the economic case is crystal clear.
Ultimately, my contention would be that President Trump likely realizes the necessity of getting the "Phase One" deal done.
He's succeeded in getting full buy-in (figuratively and literally) from the market, depending on how you want to define "buy-in." Goldman's risk appetite momentum indicator nearly hit an all-time high on Friday, and, as noted here on Thursday, the rotation out of cash and bonds and into cyclicals and stocks more generally, was in full effect headed into this week.
It is possible that the President will view the recent stabilization in the economic data and new record highs on Wall Street as an opportunity to push the issue with Beijing, especially given that the Chinese economy is on the back foot and US equities have outperformed Mainland shares in China handily over the past several months.
But if he does that (i.e., if Trump restarts the trade war), he risks yanking the rug from beneath an ebullient market and undercutting the domestic economy at a time when the Fed is fed up (so to speak) with running interference.
Oh, and incidentally, when the above-mentioned momentum indicator from Goldman is above 1, stocks usually exhibit negative asymmetry going forward, the bank noted on Friday.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.