Pro Perspectives 8/23/19

August 23, 2019

China escalated the trade war this morning, just before Jay Powell was due to make a very important speech on Fed policy.

It didn't seem to alter the message.  It was a very carefully crafted speech, but not exactly what the market was hoping to force.

In his 12-page speech, the Fed did NOT give the market (nor the President) the signal that they were planning the type of easing assault we are seeing at other central banks in the world. 

But he did make the comparison to the 1994-1995 period. 

 
We've been talking about this scenario all year, here in my Pro Perspectives notes.  In 1995, the Fed was forced to reverse course, after a period of overly aggressive period of tightening, into a low inflation, recovering economy.  As we've discussed, things worked out very well.  The stock market and economy boomed over the next five years.

Importantly, Powell described the mid-90s Fed cuts as a “response to threats to growth,” but not a change in the rate cycle.  This almost looks like a double-down on his “mid-cycle” cut comment in July.  That didn’t go over well. 

 
Still, even if the economic situation remains solid, he's given us the roadmap for another couple of cuts. 
 

Bottom line: They will keep tactically cutting rates until the geopolitical risks pass (namely the trade war).   

Now, with China's retaliatory threats this morning, and a Fed that didn't brandish a monetary policy bazooka, Trump wasn't happy.  

He responded with this …

The question everyone should be asking:  Is this tweet, threatening to deal with "a very strong dollar," a signal that a dollar devaluation is coming?

Remember, we talked about the prospects of a Plaza Accord 2.0 earlier this summer.  Here's an excerpt from my June note …

 
"There are a lot of similarities between the U.S/China standoff and that of U.S. and Japan in the 1980s. That was ended with the "Plaza Accord" — an agreement between the U.S., Japan, Germany, England and France. The Plaza Accord was a plan to balance global trade, through a 50% depreciation of the dollar (vs. the yen and d-mark).
 
… we may wake up one day and find a similar agreement has been made between the U.S. and major global trading partners (which may include China, or not). It might be a deal between the U.S. and China to “revalue” the yuan (i.e. strengthen it). Or it may exclude China (just G3 economies). With the behavior in markets the past few days, it smells like something is cooking."
 
So, what happened to stocks, following the '85 currency agreement?  Stocks rallied about 15% into the end of the year in 1985, following the deal.  Stocks were up 16% in 1986, and rose as much as 40% year-to-date in 1087, prior to the October crash. Gold rose close to 60% of the next two years.  
 
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