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Risk well and truly "on" as US and China plan talks for October

It’s becoming a familiar cycle for financial markets, this spiraling US-China trade war.

Trading floor Source: Bloomberg

And the cycle continues

The US and China pledge to hold trade-talks; the trade-talks yield no progress; the US becomes frustrated with China and hikes tariffs; China retaliates by also hiking tariffs; the US become hostile that China has retaliated to their tariff with tariffs; weeks of hostile language and threats (and Tweets) are swapped; everybody panics; policymakers are forced to try calm the panic; the US announces talks are re-starting; then the cycle repeats. The dynamics appear as clear and mechanical as that of a wrist-watch – only that no one really has any control of when and how it starts or stops.

Do investors really think much has changed?

As of yesterday, markets are at the “re-starting talks” phase of the cycle. And perfunctorily, risk is “on”, as markets price-in a world of a less-bad economic growth outlook. It’s hard to argue that, fundamentally, anyone really believes that yesterday’s announcement to restart trade-talks marks a true turning-point in US-China relations, and the outlook for the global economy. But this is market psychology at its finest. The old Keynesian beauty-contest. Market participants aren’t making decisions based on what they themselves think the market ought to do, fundamentally. They are making decisions based on what they think others think the market ought to do.

Animal spirits lifted, risk taking starts

That is: I think you’ll buy, because you think I’ll buy, so I better buy before you buy because if I don’t buy then I’ll miss my chance to buy and I will lose the benefits of buying! A bit of Seussian play on words here, but true and very salient phenomenon for global markets, nevertheless. So: with that psychology in play, in response to latest trade-war headlines, stocks have ripped higher, while bond yields have tumbled. Gold has plunged over 2 per cent. The Yen is down. The AUD is up. And SPI Futures are pointing to an 8-point jump in the ASX 200 this morning.

A US economic health-check

Market focus becomes fixed on the US economy, for a fundamental health check-up, in the next 24-hours. Monthly US Non-Farm Payrolls data is released, and is forecast to show the US economy added 160,000 jobs last month. A robust number if realized, it will still mark a very modest easing in employment growth in the US economy – a trend which is apparently unfolding as US economic fundamentals soften. Nevertheless, tonight’s NFPs are expected to confirm that the US economy remains in reasonable enough shape. The unemployment rate, at 3.7 per cent, ought to remain steady near its 50-year lows. Wage growth is expected to fall modestly.

The change in attitude to US jobs

The conversation has certainly changed around the US Labour Market and the broader US economy recently. No longer is the focus on the risk that an historically tight labour market could lead to an uncomfortable break-our in wage-growth, and therefore inflation. The monitoring of the US labour market now occurs in the context of waiting for employment growth to completely roll-over, and drive a climb in the headline unemployment rate. With economic activity slowing in the US economy, it’s believed this phenomenon will arise in time. There’s few signs it’s happening yet – but when it does, the market reaction will likely be fierce.

Markets also to look to Fed Chair Powell tonight

It will be at that moment that calls for Fed stimulus will grow louder, and Fed speakers will probably turn markedly more dovish. Until then, there’s reason for the Fed to maintain a neutral enough tone, lest they let the market get ahead of them in pricing in rate cuts. That theme brings into focus the other major US economic event this weekend: a speech to be delivered by US Fed Chair Jerome Powell. A series of Fed speakers have struck a rather dovish tone in their communications with the market this week. Market participants will be hoping Chair Powell brings much the same.

Searching for Goldilocks

With sentiment massaged by the latest happy-headlines about US-Sino trade negotiations, reassurance that monetary policy easing remains on the cards from the Fed is the final cue stock markets need to break-higher once again – perhaps to new milestone highs. As it stands, over 100 basis points of cuts are priced into the interest rate curve for the next 12 months. Investors, perhaps now more than ever, will be hoping for a whole lot of goldilocks data to keep this pricing in-line. At that, they’ll be wishing for a US Fed Chair in Jerome Powell that at least keeps an openness to cutting rates in the near future.

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