The Fed's retreat leaves just one big question mark for the stock market

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Fears the Fed would stall out the economy with too many interest rate hikes snowballed in December, along with worries about trade wars and a slowing Chinese economy. Worries about a recession drove stocks into a tailspin, with selling reaching a crescendo on the day before and morning after Christmas.

The Chinese economy has been weakening though Beijing is using both monetary and fiscal stimulus to try to jump-start it. U.S. companies like Nvidia and Apple have said their revenues have been hurt by softer Chinese sales, and analysts believe there could be a sharp stock market rally if trade issues are resolved.

Luke Tilley, chief economist at Wilmington Trust, said he views the slowing Chinese economy and trade wars as a linked issue for markets.

“Our view is we still have a solid economy. We expect 2.5 percent growth. On the U.S. side of the statement, proposed tariffs and an escalation in tariffs and retaliation between the U.S. and China, those would be material enough to change our view on the U.S. economy and growth going forward,” he said. “The resolution of those tariffs are important for the outlook.”

Tulley also puts the possibility of another government shutdown and problems around the debt ceiling talks as risks for the markets, though some strategists do not believe President Donald Trump would allow the government to be shut down again both because of public sentiment and the damage to he economy.

Markets have been hoping to see some positive developments from the two days of high level trade talks that started Wednesday between Chinese Vice Premier Liu He and U.S. Trade Representative Robert Lighthizer. The negotiators are working to reach a deal before the March 2 deadline, when the U.S. would raise tariffs on $200 billion of Chinese goods from 10 percent to 25 percent.

“We would assign a low probability to an agreement being reached this week and there is a possibility of some negative news flow should the Chinese not produce sufficient structural reforms to satisfy US Trade Representative Robert Lighthizer,” said Dan Clifton, head of policy research at Strategas. He said Lighthizer has been skeptical that China will offer enough structural reforms to prevent tariffs from escalating in March.

China has offered to increase imports of U.S. agriculture, energy and some industrial goods to narrow the trade gap, over a six-year period. The U.S. has been seeking to increase protection of U.S. intellectual property and accuses China of cybertheft. In a sign of deeper friction, the U.S. has filed charged against Chinese telecom company Huawei with bank fraud, wire fraud and stealing state secrets as well as alleging its CFO misled U.S. financial institutions about its dealings with Iran.

“Our sense is that the Chinese offer this week will go a step further by offering specific timelines that ease restrictions on foreign investment and protect intellectual property,” Clifton said. “Enforcement mechanisms to ensure compliance are also likely to be included. Missing from these proposals is anything on state-owned enterprises which is why Lighthizer believes tariffs need to continue until the Chinese feel enough pain to make further reforms.”

Clifton expects the talks could result in preventing further tariffs but not necessarily result in the removal of current tariffs.

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