Brutal 48 Hours for Stock Traders Caught in the Trump-Powell Squeeze

(Bloomberg) -- It's not that stock traders exactly knew that President Donald Trump was going to lash out at China Thursday, but some sensed something might be coming.

From the moment Federal Reserve Chairman Jerome Powell said on Wednesday trade tensions had returned to just a “simmer,” they feared something like the tariff tweet that Trump ultimately delivered. “They were holding the ‘simmering' comment in their heads,” said Kim Forrest, chief investment officer at Bokeh Capital Management in Pittsburgh.

The word implied Powell was somewhat sanguine about U.S.-China trade talks, which in turn helped explain his reluctance to commit to the additional interest-rate cuts that Trump so desperately wants. So, the thinking went, Trump would need to do something to prove to the Fed chief those talks aren't going well at all and the global economy remains in grave danger.

It's hard to know, of course, if such thoughts went through Trump's mind. Whatever the case, traders reacted predictably, sending stocks to a fourth straight losing session, including the worst two-day retreat for the S&P 500 Index since mid-May. Futures on the gauge pared a drop on Friday, but still pointed to a decline at the open after China pledged “countermeasures” if Trump goes through with a plan to levy a 10% tariff on $300 billion in Chinese imports starting Sept. 1.

“The heat has been turned up,” Forrest said. “When does it get to a boil?”

Maybe Trump's threats and the Fed are unrelated. But traders were having a hard time swallowing that. Instead, they fixated on a timeline in which Powell seems to suggest cooling trade tensions reduced the need for future rate reductions -- and a day later Trump revs them back up. It fits the pattern of a president bent on getting the central bank to submit, many thought.

“Powell was very careful to say that he was looking at three things, one of which was global growth and the extent to which that is risked by trade tensions,” said Ellen Hazen, senior vice president and portfolio manager for F.L. Putnam, which has $2.2 billion under management. “It's very logical to conclude that if trade tensions increase, given what Powell said, that would be something he would look at to evaluate a further cut.”

And compared with inflation and employment, trade offers Trump an immediate lever to affect the outlook. Whatever the truth, the result has been the shattering of calm in markets that had until this week been skating fairly placidly. It had been two months since the S&P 500 fell more than 1%, a streak that ended Wednesday. The Cboe Volatility Index jumped from around 12 to almost 18 in four sessions.

All of it made for a brutal 48 hours for investors who had hoped to celebrate the Fed's first easing since 2008. No such party materialized Wednesday, when Powell described the move as a “mid-cycle adjustment,” interpreted as meaning a small one. While Thursday started better, shares quickly suffered the worst reversal of the year after Trump launched his tariff salvo.

“I don't think it's a coincidence the announcement came today after the rate cut yesterday,” said Federated Investors fund manager Steve Chiavarone -- who also sees it as a brilliant ploy. “It's possible that while most folks were playing checkers, the president was playing three-dimensional chess here. And if he is, kudos to him.”

Powell's refusal to commit to a full-blown rate cycle wasn't sitting well with bulls to begin with. Many had been hoping for a half-point cut on Wednesday and were sorry to get only a quarter. They were happy when the market bounced back Thursday, seemingly on its own volition. Happy but worried.

“That ‘mid-cycle' comment wasn't what Trump wanted, so yes, I did expect something like this to happen,” said Yousef Abbasi, director of U.S. institutional equities and global market strategist at INTL FCStone. “Powell has a very thankless job because of Trump. Jay Powell and Trump: it's like having a very demanding parent that sees everything you do as wrong.”

Now one question for stock investors is how much of a cushion will come from expectations for a more aggressive Fed. The rates market has been recalibrating quickly. Two-year Treasury yields are down about 17 basis points since the Wednesday close, at 1.7% as of 11:59 a.m. London time Friday.

Matt Maley, an equity strategist at Miller Tabak + Co., had a more practical dilemma. After worrying for a while that the July Fed meeting would complicate his plans to go on vacation next week, he's decided to keep to his schedule but leave time for checking in.

“Now I am like, ‘OK, I see now, how it affected Trump and he affected the markets,”' Maley said. “I thought it would be a quiet vacation. Now I'll be logging in to see what's going on.”

--With assistance from Samuel Potter.

To contact the reporters on this story: Sarah Ponczek in New York at sponczek2@bloomberg.net;Vildana Hajric in New York at vhajric1@bloomberg.net;Elena Popina in New York at epopina@bloomberg.net

To contact the editors responsible for this story: Jeremy Herron at jherron8@bloomberg.net, Chris Nagi

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