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Stocks rallied sharply on Tuesday after the U.S. Trade Representative office said that some types of goods imported to the U.S. from China would be exempt from new tariffs recently announced by President Trump, while tariffs on some other Chinese products would be delayed until year end. Widely seen as a concession by Trump in an otherwise intensifying trade conflict between the two countries, the move was welcomed by investors as a significant step towards de-escalation.
The market moves on Tuesday in reaction to the tariff announcement were clear and pronounced. Major large-cap indexes, including the Dow Jones Industrial Average and the S&P 500 surged nearly 1.5% each, while the tech-heavy Nasdaq Composite rallied almost 2%. Although small caps also rebounded, the benchmark small-cap Russell 2000 (RUT) lagged for most of the day, as has generally been the case this year so far.
In other markets, government bond yields rebounded from near multi-year lows, gold prices pulled back from six-year highs, and crude oil extended its rebound, rising nearly 4% (chart below). Although bond yields indeed rebounded from long-term lows, the key 10-year/2-year yield curve came within a hair of becoming inverted, which is generally seen as a sign of an upcoming recession. The chart of just how closely the yields converged is below.
But first let’s take a look at the small caps. The Russell 2000 chart shows Tuesday’s relief rebound but also how the index has recently taken some heavy technical damage. Since the beginning of the year, the Russell 2000 has traded well below its all-time highs, unlike the large-cap indexes, which continuously hit higher record highs in the past few months. Most recently, RUT made a false breakout above a large triangle pattern in late July before plunging and breaking below that same triangle. Currently, the index’s technical structure continues to be bearish, below both its 50-day and 200-day moving averages. Major support to the downside is around 1,460.
Treasury Yield Curve Nearly Inverted
Although stocks rallied sharply due to a perceived de-escalation of the U.S.-China trade war, investors were jittery in early trading and on Monday over how close the 10-year and 2-year Treasury yields are to inverting. An inverted yield curve is an interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the same credit quality. This type of yield curve is the rarest of the three main curve types and is considered to be a rather accurate predictor of economic recession.
As shown on the chart, the yields are currently only around two basis points away from inverting. Earlier in the day on Tuesday, the yield differential went as close as one basis point. The last time this key yield curve was inverted was all the way back in 2007. Needless to say, markets are watching very closely.
Crude Oil Surges Almost 4%
Also in response to relieved concerns about the U.S.-China trade conflict on Tuesday, crude oil prices rallied nearly 4% as persistent worries over declining energy demand from both China and the U.S. eased. An escalating trade war between the two countries has been considered a severe threat to an already slowing global economy, which has the potential to place heavy pressure on oil demand.
As seen on the chart of U.S. crude oil futures (West Texas Intermediate), oil prices rose sharply on Tuesday, extending the rebound from key $51.00 support. Tuesday’s surge boosted price above both the 50-day and 200-day moving averages. On any extended push higher, a key upside resistance level is around $60.00.
The Bottom Line
While stocks rallied sharply Tuesday on what appears to be a U.S. tariff concession, major economic risks persist. If the 10-year/2-year yield curve inverts, expect more heavy market volatility. Further driving such potential volatility is a U.S.-China trade conflict that is likely far from over, although we may have been granted some respite for the time being.
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