E Algorithms Could Be Making US-China Trade Volatility Worse

US equities have become increasingly volatile amid US-China trade tensions and the S&P 500 has actually delivered a near-flat return since January 2018. Markets have become very headline-driven, portraying immense sensitivity to even Tweets by the US President. This has led to recurrences of irrational behavior where markets tend to rally on even the slightest ‘positive’ trade developments, even when there has been no meaningful progress, and computer programs are playing a vital role in these events.

Have recent positive developments really been meaningful for the economy?

Let's take the recent development as an example; equities rallied strongly on the news that China is open to a partial trade deal. However, digging deeper into the news revealed that their requirements are unlikely to be accepted by the Trump administration. All China is willing to offer is buying more agricultural products, for which in return they want to eradicate further tariffs. They are certainly not willing to make any concessions on the more difficult negotiating-points, such as industrial reforms. President Trump will want to avoid losing face by any means prior to the 2020 elections, hence will likely push China for more concessions as opposed to settling for more agricultural purchases. In fact, even when Trump has agreed not to raise more tariffs, it has not lasted long before he goes ahead and charges additional duties on Chinese goods. Therefore, such headlines and developments are quite meaningless with regards to the economic outlook. Therefore, it makes little sense for markets to rally strongly on such events.

Furthermore, another major factor that has been driving equity prices is the easing monetary policy stance of the Fed. The central bank has already cut rates twice this year, with at least one more expected this year. Though recent Fed minutes revealed that even Fed officials believe the markets are going too far with their rate cut expectations, and thus the market is clearly setting itself up for potential disappointment ahead. Moreover, amid the recent repo market turmoil, Fed chair Powell stated that the Fed would restart purchases of Treasuries to improve liquidity conditions and thereby better control the effective fed funds rate to keep it within the target range. This headline also induced markets to rally higher. While easier monetary policy is certainly helpful amid deteriorating global growth conditions, to what extent can lower interest really be effective at encouraging corporations to engage in capital expenditure when trade conditions are only getting worse? Cheaper borrowing costs are certainly not a magic fix to rising tariff bills for US companies. Hence the fact that the market still rallies strongly in reaction to such headlines seems irrational.

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