The stock market has been driven by two main dynamics in recent weeks: the trade war with China and expectations for Federal Reserve interest rate policy. Global stocks sank 6% in May after the re-escalation of trade tensions. Those losses have been mostly recouped as investors now expect the Federal Reserve to lower interest rates to counteract the effect of the trade war on the economy.
The near-term outlook for the markets is captured in the adjacent diagram. Progress on the trade war combined with Fed rate cuts could be a powerful combination for the markets, likely leading to improved performance among economically sensitive stocks in the U.S. as well as emerging market equities. On the flip side, continued trade tensions combined with a “hawkish” Fed could cause most investments to decline, similar to the fourth quarter of 2018.
The actual outcome may be somewhere in the middle, with markets benefiting from either trade relief or lower Fed interest rates, as the White House and Fed compensate for each other’s actions. Markets ought to be able to perform reasonably well in this scenario; indeed stocks have posted modest gains this quarter despite this mixed policy bag.