U.S. equities in the S&P 500 endured their worst week of the year, falling nearly 2.2 percent, as President Trump followed through on his threat to raise tariffs on Chinese imports. A fifteen percent increase, from 10 to 25 percent, on the second tranche of Chinese goods took effect on Friday, and the procedural clock began to tick on the threat to impose tariffs on the $325 billion remainder of Chinese imports. China has since announced a tariff increase of its own on U.S. imports to take effect on June 1. 

The selloff in equities certainly could have been worse. As prices fluctuated throughout the week in response to statements and tweets about the status of the negotiations, stocks staged several heroic intraday comebacks to limit the damage, and the S&P 500 managed to end the week above its 50-day moving average. But, as the talks ended with apparently little progress and no firm schedule for their resumption, investors have been left with an uneasy feeling that there may be more downside ahead. (S&P 500 futures this morning were down approximately 2 percent.) As it is, volatility spiked sharply higher last week. After closing the previous week at a level of 13, the VIX index of implied volatility rose as high as 23 on Thursday, before finishing the week at 16.

Bonds were the beneficiary of the new uncertainty. The ten-year Treasury yield fell six basis points to 2.47 percent, and in early Monday trading is lower at 2.42 percent. The two-year slipped nine basis points to 2.25 percent. High yield spreads widened rather sharply, climbing 29 basis points to 401 using the Bank of America Merrill Lynch High Yield Master II index.

Trade Talks Left Markets Spinning, But There was Some Good News Elsewhere

Where the talks go from here is uncertain. President Trump is certainly emboldened by the bipartisan support his hard line has garnered. And the strong U.S. economy provides the cover to pursue it. But, there is undoubtedly an economic cost to that strategy, especially the longer it persists, not just in higher prices borne primarily by consumers, but in the disruption to corporate supply chains and impairment of the strategic planning process. This certainly factors into the domestic political calculus, as the U.S. election cycle draws closer. China has no such concern.

On the other hand, exports to the U.S. are more important to China than are U.S. exports to China. Just last week the International Monetary Fund (IMF) estimated the potential impact of the trade war is approximately three time greater than its impact on the U.S. Some are pointing to the G-20 meeting in June, as a possible opportunity to reignite the talks.

Although the preoccupation with the trade talks last week was head-spinning, there was some encouraging news elsewhere. On the corporate earnings front, first quarter results are now by some measures expected to conclude with a slight gain, a far cry from estimates of just a few weeks ago that called for a decline in the vicinity of 4 percent amidst warnings of an earnings recession. On the economic front, U.S. consumer prices in April rose less than expected, leaving the CPI at 2.0 percent year-over-year, and the core rate at 2.1 percent. And in Germany, industrial production surprisingly rose for the second straight month in March as exports surged. Germany reports first quarter GDP this week.

Investors Keeping an Eye on Economic Data and Tensions in the Middle East

The U.S. economic calendar this week is quite full, including reports on retail sales, industrial production, housing starts, leading indicators and consumer sentiment. China is scheduled to report retail sales, industrial production, and property investment, while the Eurozone will report on first quarter GDP, March industrial production, and April consumer prices.

Lastly, tensions in the middle east are rising as the U.S. continues to squeeze the Iranian economy with sanctions while increasing its military presence in the region. And crude oil prices are rising on Monday in response to reports of confrontations with oil shipments in the region. Brent crude is higher by 2 percent to $72.06 a barrel.

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The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.

The Chicago Board Options Exchange (CBOE) Volatility Index (VIX) is a widely used measure of market risk. It shows the market's expectation of 30-day volatility. The VIX is constructed using the implied volatilities of a wide range of S&P 500 index options.

The Bank of America Merrill Lynch High-Yield Bond Master II Index is an unmanaged index that tracks the performance of below investment grade U.S. dollar-denominated corporate bonds publicly issued in the U.S. domestic market.
Indexes are unmanaged and are not available for direct investment.

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