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Expectations for a Fed bailout for markets and the economy rose sharply after President Donald Trump's surprise threat to put tariffs on all Mexican goods if Mexico doesn't do more to stop immigrants from entering the U.S.
Many investors believe in the "Trump put," — the idea that he would act to limit the stock market's downside because he views the market's performance as a reflection of his own success. But after Trump's announcement on Twitter on Thursday night, investors may be considering whether the Fed could be the real backstop.
That was evidenced in the sharp jump in market expectations Friday for a Fed rate cut. Fed funds futures were pricing a 64% chance of either a half percent rate cut or two quarter-point cuts by the end of the year.
J.P. Morgan Chase economists also promptly called for two Fed interest rate cuts by December, changing their view from an equal chance for either an interest rate hike or cut. Barclays economists also said they expect two rate cuts, one a half percent cut and a second quarter point cut, based on a slowing economy, extended trade war with China and the Mexican tariffs.
"If the Administration follows through on the proposed actions, we believe the adverse growth implications would prompt Fed easing. Even if a deal is quickly reached with Mexico, which seems plausible, the damage to business confidence could be lasting, with consequences that might still require a Fed response," the J.P. Morgan economists said in a note Friday morning. "Accordingly, we now look for two 25bp reductions in the federal funds rate target, in September and December."
The Fed has said it was pausing in its rate-hiking cycle, and it is on hold while it watches the economy. Increasingly, economists have moved away from the view that the Fed's next move will be a hike but traders have been betting on a cut for several months.
"The downside risk is greater than the upside," said Ed Keon, chief investment strategist at QMA. "It's hard to say whether these Mexican tariffs will go into effect or not. It just adds another brick to the wall of worry, which eventually we'll climb."
Keon said the idea of a Trump put still exists but it's surrounded by more uncertainty. "I think people still have the perception that he wants the market to go up, and he'll take action to help it, but that's not the only thing on his agenda and in some ways his whole campaign was based on eliminating illegal immigration. This is one of his core beliefs."
Trump added a new element of uncertainty to his use of tariffs, but it's not clear the tariffs will be implemented since two key advisors, U.S. Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin, reportedly disagree with the tariffs.
"So this is no more about free and fair trade, reciprocity, and protection of technological expertise. Tariffs can be thrown around as an economic bomb for anything now. Global growth rates will only continue to suffer," said Peter Boockvar, chief investment strategist at Bleakley Advisory Group.
The S&P 500 was 1% lower Friday, after Trump said he would start with 5% tariffs June 10 and raise them to 25% if Mexico does not stop the flow of immigrants across the U.S. border.
But some analysts said the market actually could have been down more Friday. Jim Paulsen, chief investment strategist at Leuthold, said it's because investors are looking at two potential ways the market will be bailed out if the things turn really bad.
"You could have a 3 a.m. [Trump] tweet that suddenly changes the landscape on the trade war, or you could have the Fed announcing it's going to cut interest rates, with the yield curve as inverted as it is. I think those are the type of things that keep people from getting totally blown out," said Paulsen. "You have two big things that could change overnight and make the upside risk as big as the downside risk. It could be a slingshot [higher] if one of those things happens."
But he added that Trump risks going too far. "I think there's slingshot potential on either side of this. That's why I think there's still a bid [in stocks]. People don't want to miss out," Paulsen said. "There's the risk of it feeding on itself and freezing confidence."
Lori Calvasina, chief U.S. equities strategist at RBC, said Trump has confused the market, and that may make investors look more toward the Fed for relief. She expects the market to continue to decline into the summer, as investors try to sort out the impact of tariffs on the economy and earnings.
"I think conflating trade with immigration is something that's definitely thrown the Street for a loop," she said. She expects more selling— at least a 10% decline before it's over. The S&P is down more than 6.6% from its all time high, reached in early May, before Trump ramped up the trade war with China.
"The put that's more on my mind is the 'Fed put' than the 'Trump put.' I still think the Fed is not going to cut rates unless they see a deterioration of the data," said Calvasina. She said the market was anticipating a resolution of the new trade deal instead with Mexico and Canada, just as it had a Chinese trade deal until early May.
"The Mexican tariffs came out of left field," she added. "People thought USMCA was on the way to being done. This is the second thing in a row that was thought to be done, and now it doesn't look like it's being done." She was referring to the failure of U.S. and Chinese negotiators to reach a trade agreement earlier in May.
Stocks have been falling through the month on fears the trade war between the U.S. and China would hurt an already weakening economy. At the same time, the bond market has been sending scary signals of its own with interest rates sinking to multiyear lows. The 10-year Treasury yield, around 2.55% at the beginning of the month, was at 2.17% Friday, and the 2-year yield was at 1.99%.
Prior to May, stocks had been moving higher since the beginning of the year on expectations for a China trade deal. Through April, the market had the third best start of a year since World War II.
"My thinking has been [Trump] would not let the market go down 20% like he did in December, ... but I don't know how he digs his way out of this one," said Calvasina, adding he could delay the tariffs while something is worked out.
Trump administration officials have called for Fed rate cuts, and the president has repeatedly criticized the Fed's interest rate policies.
"His irrational action, what if it isn't so irrational? What if he's trying to break the Fed to get his rate cut and get a deal on trade," Paulsen said. "I'm not saying I agree with it, but that's the type of scenarios that have to be in an investor's head."