The debate in Washington over the next round of fiscal stimulus and rising tensions between the White House and China could act as brakes on the stock market in the coming week.
Stocks rallied in the past week but were more sluggish Friday, as investors watched stimulus talks between Democrats and the Trump administration stall out. Investors also were concerned that President Donald Trump's executive order banning U.S. transactions with Tencent's We Chat and Bytedance's Tik Tok would accelerate the deterioration of relations between the U.S. and China and draw retribution.
Just ahead of Friday's market close, Treasury Secretary Steven Mnuchin said just that he is recommending the White House move forward with executive orders on unemployment, student loans and rental foreclosures. He said a compromise could not be reached with Democrats, who wanted a $2 trillion package. Stocks edged higher after the announcement though details of the orders and how any assistance could be funded were unclear.
"It's an attempt to bring the Democrats back to the table to negotiate a deal by threatening to use an executive order. They may be able to get some things down, but it won't be enough to create the bridge they need while the economy continues to repair itself," said Michael Arone, chief investment strategist at State Street Global Advisors.
"Part of the reason stocks have held in there well and continue to melt up is that one of the things that is priced in is a fifth fiscal policy package of $1.5 trillion. if we don't get one, I do think the market will retrace lower to reflect a lack of stimulus," said Arone. "The recovery will stall out without one."
As for China, it has so far not taken actions against U.S. companies, even with the Trump administration's moves to block Chinese telecom giant Huawei from using U.S. parts. The latest steps, however, raised concerns that China could find ways to retaliate, and that the U.S. will bar Chinese IPOs.
"On balance, continued hostility toward China is going to be a continued net negative for U.S. companies that are revenue exposed to China," said Julian Emanuel, head of equities and derivatives strategy at BTIG. "We know the exposure is very centered in the Nasdaq names."
Emanuel said the stock market is entering a seasonally weak time, and while market psychology is still strong it could start to change. "The seasonals are starting to shift negatively. We all know September is a poor month and the degree of the escalation of the tensions between the U.S. in China is not a surprise, but the degree of the escalation over the last 48 hours is," he said. "It's not changing psychology, but it's challenging bullish psychology."
In the coming week, there are some final earnings of the season, including technology company Cisco and food company Sysco. Some travel companies including Royal Caribbean report, as does consumer goods company Tapestry. In the week after, big retailers roll out their reports in the final earnings burst of the quarter.
Economic reports could be important in the coming week, as investors watch consumer price index inflation data Wednesday and retail sales Friday. Retail sales should provide a window into the consumer, as workers returned to their jobs but also faced uncertainty because of reclosings.
CPI is important as the market has been assuming inflation will ultimately start to show gains because of the weakening dollar and ballooning budget deficits. CPI last month showed a 0.6% increase month over month.
The pro-inflation trade has become important and has driven investors into stocks, gold, and out of the dollar.
The dollar could be the key to the fate of markets in the coming week. The U.S. currency was edging higher Friday but is still down about 3.5% over the past four weeks. Gold declined Friday, and Treasury yields moved lower.
"The dollar ... to me it just continues to be an important barometer that has a unique intersection of rates, inflation and risk assets," said Arone. "With rising China, U.S. tensions and combined with the fact that there's uncertainty about the fiscal policy package and the fact the dollar has declined so quickly, many are expecting it to catch a bid here and rebound."
Part of the move in the dollar was based on the idea that huge government spending would increase the government's deficit and Treasury issuance. Emanuel said the news on stimulus could have a big impact on the trade.
"We would make the argument the baseline expectation was a trillion dollars worth of stimulus to be implemented sometime in the month of August. Anything below that expectation is likely to cause the dollar to strengthen," said Emanuel. "It's a momentum and positioning trade as well as what has been ... the unwind of an asset diversification trade."
The stalling of talks could shift the market's view that the U.S. is willing to spend any amount to fight the impact of the coronavirus. "It's changing the market psychology that the government's propensity to spend infinitely is not as great as it was earlier in the week,," Emanuel said. "The dollar rallying, from our perspective, is a direct threat to a lot of these momentum trades."
Strategists said a strengthening dollar could be a headwind for stocks.
"Given the friction with China, to the extent the inflation numbers come in weaker than expected, the argument being that whole weaker dollar asset diversification has helped feed into increasing inflation expectations," said Emanuel. "If the inflation data does surprise to the downside, given the rally in inflation ...it's further potential for the unwinding of the short dollar trade and the unwinding of the long gold trade which in our view bleeds over into stocks."
Earnings: Marriott, Simon Property Group, Occidental Petroleum, Liberty Media, Tilray, IAC/InterActive, International Flavors and Fragrances, Canopy Growth, SeaWorld, Barrick Gold, Duke Energy, Royal Caribbean, DoYou
10:00 a.m. JOLTS
4 p.m. Chicago Fed President Charles Evans
6:00 a.m. NFIB survey
6:30 a.m. PPI
8:30 a.m. CPI
10:00 a.m. Boston Fed President Eric Rosengren
11:00 a.m. Dallas Fed President Robert Kaplan
2:00 p.m. Federal budget
Earnings: Tapestry, Applied Materials, Brookfield Asset Management, NetEase, Azek
8:30 a.m. Initial claims
8:30 a.m. Import prices
8:30 a.m. Retail sales
8:30 a.m. Productivity and costs
9:15 a.m. Industrial production
10:00 a.m. Consumer sentiment
10:00 a.m. Business inventories