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Market support for Trump or unwarranted equanimity?

17 May 2019

A little over one week into the escalation of the US-China trade wars, stock markets have calmed and even made a partial recovery from last week’s sell-off. Globally, stock markets are now trading around 3.5% below their highs, but that is still only about a third of a correction  (a ‘correction’ is defined as a 10% decline). Given how extended stock markets appeared following the extended recovery since the beginning of the year, they could have been described as being in a state where investors start to search for reasons to take profits.

So why is it that stock markets have stabilised even though the rapid turnaround in the trade negotiations, that was initially talked up by the Trump administration, no longer seems plausible? Well, more research has been conducted into the likely short, medium and long term damage potential to the US and global economy, and the conclusion has broadly been that the long term damage potential is frightening, but over the shorter period of the next few months the deterioration of the economic outlook is fairly small. Not dissimilar to the aftermath of the 2016 Brexit referendum, in a way. And just as then, as long as economic sentiment does not sour to create second order effects, the markets may actually not be too far off.

From that angle capital markets are not just a barometer of change in the economic climate, but their reaction can influence the climate itself – make the weather change, if you will. Paradoxically therefore one can interpret the relative market calm as implicit encouragement for the Trump administration to play hard ball against the Chinese side – at least over the coming months. Whether this stance will pay off will only become clear in time.

Back in the UK, looming currency market turmoil next week was averted by Theresa May’s announcement that she would agree in June to a time plan for her stepping down regardless of whether she wins or loses a fourth attempt to get Parliament to pass her Brexit deal. Turmoil averted, because on the basis of the current polls for the European elections, the Conservatives will suffer such catastrophic declines that the pressure for her to resign there and then could have created a power vacuum that would have sent £-Sterling into another downward spiral.

However, £-Sterling still declined against the US$ to levels last seen at the end of last year, as international investors realised that her stepping down will usher in a more determined Brexiteer to lead the country, given it is the Tory party membership that will elect the next leader not Parliament or the Conservative MPs. Depending on the severity of the outcome of the elections next week it may also become plausible for the Conservatives to swing behind a hard Brexit agenda and agree with Corbyn to call a general election in the hope of regaining a parliamentary majority.

Sadly this means the Brexit respite has ended already and we will have to return to monitoring every new turn carefully for its potential economic impact. A bit of a shame really, because the UK’s economic trend has improved further over the Easter break as has Continental Europe’s.

In summary then, the economy and markets are doing their best to ‘keep calm and carry on’ but we will have to watch the political world very closely for any indications that this calmness may turn irrational.