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Trump's trade war has 2 audiences: China and the markets

In the midst of a high-stakes battle to reshape the U.S.’s bilateral trade relationship with China, President Donald Trump appears to be negotiating with two parties: China’s leadership in Beijing and investors unsettled by the prospect of a drawn-out trade war.

Trump’s sudden decision to slap higher tariffs on $200 billion worth of Chinese goods — which took effect on Friday —walloped major benchmarks for much of the week.

On Friday, the Dow (^DJI) and Nasdaq (^IXIC) reversed the session’s steep losses after Treasury Secretary Steven Mnuchin said negotiations between the two sides in Washington were constructive, even after the 25% rate on Chinese goods took effect after midnight.

The latest unexpected turn occurred just days after the Dow and S&P 500 both set records, a fact not lost on Trump as he issued a blizzard of Twitter posts on Friday that sought to play up the economy’s underlying strength.

Noting that the administration “has been very sensitive to the markets,” Aditya Bhave, global economist at Bank of America-Merrill Lynch, suggested the escalation of bilateral tensions “was a complete surprise to investors. This means that markets could be in for a bumpy ride before a trade deal is reached.”

It underscores the delicate balancing act Trump is navigating as he seeks to address U.S. trade concerns — while placating a booming market and economy, for which he’s repeatedly sought to take credit.

Markets are viewing the president’s tweets as “a negotiating tactic, pushing things to the edge to get the best possible deal, or just speed things along,” said David Donabedian, chief investment Officer at CIBC Private Wealth Management. “That doesn’t mean it’s going to work.”

For months, Wall Street has aggressively priced in a resolution to the trade fight, and that optimism helped put a floor under stocks. Although tariff hikes took effect Friday — an event to which Goldman Sachs assigned a 40% probability at the start of the week — an eventual deal remains the base scenario of most market observers.

“Yes, there will ultimately be an agreement, but markets have priced in a best of all worlds outcome, a smooth path to an agreement,” Donabedian added. “That’s just not how President Trump negotiates.”

El presidente Donald Trump habla en la Casa Blanca, Washington, 9 de mayo de 2019. Trump sostiene que las conversaciones comerciales entre China y Estados Unidos proceden “de manera muy cordial” a pesar de los nuevos aranceles impuestos por Washington sobre importaciones chinas por valor de 200.000 millones de dólares que entraron en vigencia el viernes 10 de mayo de 2019. (AP Foto/Evan Vucci)
President Donald Trump, speaking at the White House on May 9 (AP/Evan Vucci)

Given that the effect of the new tariff rates won’t take effect immediately, analysts believe it gives the Trump administration latitude to hammer out an agreement. This week, Fundstrat’s Tom Lee said that it still expects the S&P 500 Index (^GSPC) to end 2019 at a new record of 3,125, expecting that investors will “buy this dip.”

It all but guarantees markets will continue to be whipsawed by expectations, and Trump’s tweets about the status of negotiations — even as uncertainty festers about how long it will take the two sides to strike an accord.

“For one that lives by the stock market is [Trump] ready to die by it? For one that lives by the tariffs is he willing to die by it?” asked Peter Boockvar, chief investment officer at Bleakley Advisory Group, in a research note to clients this week.

“Stated simply, we've reached a binary point in this process. We know what the stock market wants right now and we know what the global economy needs right now, an end to this battle and an elimination of the tariffs,” Boockvar added, questioning whether Trump could indeed secure a lasting, substantive deal if it came at the expense of the market’s upheaval.

Javier is an editor for Yahoo Finance. Follow Javier on Twitter: @TeflonGeek

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