Based on the behavior of the S&P 500 in the last 6-7 months, there are two big stories that will likely continue to dictate market direction through the remainder of 2019 (and possibly beyond).
The two biggest current news stories in the financial markets are the U.S.-China trade war and developments related to U.S. Federal Reserve monetary policy. The latter subject could also be expanded to include central bank activity from other parts of the world as well.
A simple glance at a historical chart of the S&P 500, overlain with important news developments related to these two narratives, drives home this point fairly clearly.
After experiencing a serious correction in November and December of last year, a broad-based rally in the S&P 500 was ignited in January after news broke that the U.S. Federal Reserve was “taking a pause” on interest rate increases.
The Fed had been raising interest rates steadily the last few years, and this policy approach culminated with one last quarter-point raise at their final meeting on Dec. 18-19, 2018. The timing of that particular interest rate increase made it all the more intriguing that the Fed reversed posture only a few short weeks later in January 2019.
Instead of hiking interest rates further at the start of 2019, the Fed announced that it was taking a “wait and see” approach to ongoing economic policy. This announcement was lapped up like a freshly brewed green tea by jittery investors, and the ensuing calm helped kick-off an impressive four-month rally in the S&P 500 that lasted through the end of April.
It wasn’t until the 2019 calendar turned to May that the other major market narrative reared its ugly head, and basically halted the euphoria in its tracks. This time headlines were dedicated to US-China “trade war” negotiations, which experienced a serious derailment in early May.
After months of bilateral talks failed to produce discernible progress, President Trump announced in May that he was notching up tariffs on Chinese goods entering the United States. Equity markets reacted unequivocally to that news, by plummeting lower.
In the wake of the new tariffs, the S&P 500 fell approximately 6% in the month of May.
It likely would have fallen further, if not for the US Federal Reserve.
In June, the Fed rescued equity markets once again by announcing that they were no longer considering raising interest rates. In what can only be described as a complete U-turn, leadership within the US central bank even indicated they might be willing to embrace an interest rate cut at some point in 2019 or 2020.
The reversal in Fed posturing ignited a similar reversal in the value of global equities. Only a few weeks after the Fed changed course, the S&P 500 rallied from its May lows and established a new intraday, all-time high on June 21.
Currently, interest rate futures markets are indicating that the Federal Reserve will cut rates not once but twice in the next 52 weeks. Back in November of 2018, the same indicators suggested the Fed would raise interest rates twice in 2019.
That’s a serious turnaround, and all this uncertainty around US monetary policy may help explain why equity prices have been effectively been riding the rollercoaster for the last eight months.
But there may also be a good explanation for the recent reversal by the Fed, which all ties back to the entity’s “dual mandate.”
While the Fed is specifically tasked with keeping unemployment as low as possible, the quasi-government body is also tasked with ensuring that the prices of goods and services in the United States don’t rise or drop too quickly in value. This second mandate was added to the Fed’s checklist via the 1977 Federal Reserve Act.
In sum, that means that while employment levels throughout the country are extremely robust, lagging growth in prices and wages are still keeping Fed leadership awake at night.
Overall levels of inflation, which are closely watched by economists, have struggled to keep pace with the Fed’s target level of 2%. It’s this data which is most often cited as the reasoning behind possible rate cuts in 2019 and 2020.
So will the Federal Reserve cut rates by a quarter percent at its next meeting in July?
The answer to that question most likely depends on the other major market narrative – the trade war. The presidents of the United States and China are scheduled to meet and discuss this topic on the sidelines of the G20 in Japan in June.
If nothing substantial is announced in the wake of that meeting, or worse yet, President Trump raises tariffs on China again in July, then one can easily see how the current market euphoria could once again evaporate, and fast.
Based on that scenario, one can see how the Fed’s new “accommodative” approach might be brought to bear for another market rescue. Likely via a rate cut at its July 30-31 meeting.
Another possible scenario, with much lower probability, is that a U.S.-China trade agreement is reached
If that is the case, it’s a lot harder to envision the Fed intervening substantially in July, and instead sticking with their “wait and see” approach.
Either way, recent history suggests that developments related to the ongoing US-China trade war, as well as ongoing posturing by the Federal Reserve, will continue to dictate market sentiment and direction for the foreseeable future.
The only story that could “trump” these two themes would be the outbreak of war between the United States and Iran. Tensions have been escalating between the two countries since a sixth oil tanker was attacked in the Middle East on June 13. While any international military conflict seizes the attention of the financial markets, outbreaks in the Middle East are of particular interest because of potential disruptions to the crude oil supply chain.
Traders looking to keep abreast of all these market narratives, and more, may want to tune into tasytrade’s live programming (watch tastytrade live now) over the coming weeks and months.
The great thing about fast-moving markets such as these is that they typically offer plenty of new trading opportunities, as corrections in equity markets often come with silver linings – especially for proactive investors.
Sage Anderson is a pseudonym. The contributor has an extensive background trading equity derivatives and managing volatility-based portfolios as a former prop trading firm employee. The contributor is not an employee of luckbox, tastytrade or any affiliated companies.