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John Higgins believes U.S. stocks may have seen their best days even if the United States and China settle their bitter trade war.
Monday’s slump on the S&P 500 was clearly sparked by Beijing’s retaliation in the escalating trade battle, said Mr. Higgins, chief markets economist at Capital Economics.
But “an accompanying ‘reinversion’ of the Treasury yield curve suggests that the best days for U.S. equities may be over even if the two economies eventually resolve their dispute.”
To recap, the most recent round of talks between the U.S. and China in Washington went nowhere, leaving markets to ponder the impact on global economic growth of a protracted fight.
President Donald Trump raised tariff levels Friday, and threatened more, prompting China to fire back Monday.
Mr. Higgins cited the previous inversion last month, when the three-month Treasury yield topped that of the 10-year, spooking markets.
“Such an inversion of the curve has often been accompanied, or followed, by a downturn in the U.S. economy and stock market,” Mr. Higgins said.
Many market players “downplayed” the significance of the March inversion, he added, believing the Federal Reserve would sit on its hands so as not to derail the economic expansion.
They also believe that the Fed’s asset purchases, a stimulus measure, had skewed the curve.
“Admittedly, much off the pullback in equity prices this month can be pinned on worries about trade, which could quickly ease if the U.S. and China hammer out some sort of deal,” Mr. Higgins said.
'But their differences run deep, so concerns would probably linger," he added.
“More importantly, our view remains the U.S. economy will slow sharply regardless, as the Fed’s prior tightening of policy takes more of a toll.”
Thus, Mr. Higgins said, Capital Economics projects U.S. stock prices will sink further, with the S&P 500 ending the year at 2,300.
“We don’t think that the curve will have to invert significantly for this to happen,” Mr. Higgins said.
“Indeed, it probably won’t invert much more at all, if we are right that the Fed has already delivered its final rate hike in this cycle. After all, the curve has tended to steepen again not long after this point has been reached.”
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