Trump Needs China Deal and Shares Rally. He Might Not Get Each

(Bloomberg) — President Donald Trump wants the stock market to celebrate if he strikes a trade deal with China. Investors may struggle to deliver.

The outcome could fall short of the definitive resolution of trade tensions that equities investors have priced in. Instead, the most likely scenario is an accord with few details, or a paucity of specifics on which tariffs will stay and which may go.

Or, as Secretary of State Michael Pompeo pointed out this week, Trump could walk away from the table during a meeting with China’s Xi Jinping — as he did with North Korea’s Kim Jong Un — potentially taking trade tension to a new level.

The reality is that trade friction could remain a fixture of American policy. Trump, the self-proclaimed “Tariff Man,” has drawn bipartisan support for his tough stance with China. Even Senate Minority Leader Chuck Schumer has praised the president for using tariffs as a negotiating tool.

“The flaw in how the market thinks is that it’s less concerned than it should be about the longer-term outlook for free trade and what it could mean for corporate profitability, and whether the current global trading system is going to work as it has in the future,” said Ronald Temple, co-head of multi-asset and head of U.S. equity at Lazard Asset Management.

Trump’s dilemma, as he seeks to reignite the rally that drove stocks higher the past two months, is that he’s raised expectations. His tweets in the past week that negotiations are “moving along nicely” means markets may be vulnerable if the pact doesn’t live up to its billing.

Sunday’s Example

A prime example of what’s at stake came Sunday, when reports surfaced that an accord eliminating tariffs was imminent. While stock futures registered small gains in the hours after the news, U.S. equities have been down in the three days since.

Anything could happen, as Trump himself said on Wednesday: It’s “either going to be a good deal or it’s not going to be a deal.”

He’s pushing for U.S. negotiators to close a trade deal with China soon, concerned that he needs a big win on the international stage — and the stock-market bump that would come with it — in advance of his re-election campaign. He has taken note of market gains that have followed signs of progress and has told his advisers he’s concerned that the lack of an agreement could undermine stocks, Bloomberg News has reported.

Trump has repeatedly taken credit for equities strength, citing his own economic policies as the key driver. The S&P 500 has risen around 30 percent since he was elected, and is up about 10 percent in 2019.

Global Risk

Investors view the outlook for the relationship between the world’s two largest economies as a possible tipping point that could spark a sustained slowdown in global growth. Markets appear to have a binary set of expectations from Trump on trade, and he has a similarly black-and-white view of how investors would act on a deal.

The best-case scenario for investors is no more tariffs.

“In the short-term, the best news is that tariffs go to zero,” said Michael Kushma, chief investment officer for global fixed income at Morgan Stanley (NYSE:MS) Investment Management. If Trump walks away from the negotiating table during Xi’s visit, markets would take that “very negatively,” Kushma said. “The market is not ready at all for any further escalation.”

Chances are the U.S. may push to retain some tariffs to force China to stick to concessions. With trade weighing on the outlook for both economies — the Federal Reserve noted it as a headwind in its latest Beige Book — neither side can afford that scenario.

Bonds Too

Bond traders are also keenly focused on the trade negotiations — the outlook for the Fed may hinge on a deal. Rates markets have more or less given up on policy tightening this year after the Fed’s dovish pivot. But that could change on an accord.

“If you resolve the China trade issue, that removes one potential significant risk to global growth, which theoretically could make the Fed more willing to raise at some point,” said Stephen Myrow, managing partner at Beacon Policy Advisors in Washington and a former Treasury official.

And therein lies the catch that exposes Trump’s goal of trying to rally markets on a deal: A turbocharged equities market could very well revive Fed rate-hike bets for 2019.

Chalk up that risk — higher borrowing costs — as something that might work to cap gains in U.S. stocks.

(Updates market performance.)