When we discussed the latest BofA Fund Manager Survey yesterday, we highlighted the sudden, unexpected drop in buyside perception of global economic health, as expectations for faster global growth tumbled by more than half, or 19% to net 18% in March, the lowest level since Brexit. Additionally, 74% of investors surveyed now believe the global economy is in the late cycle – i.e. pre-recession – the highest percentage in survey history, while at the same time respondents voiced the highest inflation expectations in over 13 years, suggesting stagflation may be just around the corner.
However, another notable highlight from the survey, which needs further emphasis in light of what is about to happen, is what the “smart money” thinks is the biggest “tail risk” right now. As a reminder, Politico reported that the White House is preparing to announce on Thursday a plan to eventually hit China with tariffs and other trade restrictions, and as reported earlier, China is already planning its trade war retaliation which is aimed at President Trump’s support base, including levies targeting U.S. agricultural exports from farmbelt states such as soybeans, sorghum and live hogs.
Which logically leads us to the answer of what is the biggest “tail risk” on Wall Street now, namely trade war.
This is the first time Trade War has emerged as the top risk according to Wall Street, and follows last month’s top risk of inflation and bond crash.
This, then brings us to another recently conducted survey by BofA, one focusing on FX and rates traders, and which asked 66 clients “what impact do you expect from an escalation of US trade tensions”, or in other words – how will you trade the coming trade wars?
The answer was that investors overwhelmingly anticipate increasing trade tensions will result in lower equities as “the preferred play” for 40% of respondents; meanwhile another 19% will short the dollar. Oddly, 17% believe that Trump’s trade war is merely a negotiating gambit and there will be no actual escalation (Trump is about to prove these skeptics wrong), while only 6% will go long Treasurys as global trade shrinks (perhaps on the assumption that trade wars are mechanistically inflationary).
In other words, unless the survey respondents are massively lying, the market reaction to a full blown trade war will be a plunge in stocks, which reminds us of what Marko Kolanovic said last week when he suggested that if Trump does pursue a trade war, he opens up a path to not only losing the mid-term elections, but also impeachment, to wit:
A significant trade war started by this administration would destabilize global equity markets. Should this happen ahead of the November election, it would impair the administration’s ‘market scorecard’ and likely lead to an election loss. Lost elections open a path to impeachment, and other complications.
That said, Trump now sees a trade war with China as the logical next step of his evolving “MAGA” process, and appears convinced it will result in broader support for his administration, at least among the core. Which leads to the question: what is more important for Trump: a stock market near all time highs, or being seen as a trade hawk, brave enough to boldly launch trade war on China, damn the consequences.
For now, the market is confident the answer is the former, although should Trump indeed unveil $60BN in Chinese tariffs today, it may get a very rude awakening… and opportunity to BTFD all over again, as an S&P crash is the surest way to halt the Fed from hiking rates for the foreseeable future if not launch QE4.