Why optimistic stock-market investors and pessimistic bond traders are both wrong about trade wars

When it comes to trade and financial markets, maybe everyone is getting it wrong.

The bond market “is too pessimistic, the equities market too optimistic, and the FX market complacent,” said Bank of America Merrill Lynch currency strategists Athanasios Vamvakidis and Adarsh Sinha, in a Wednesday note (see chart below).

Bank of America Merrill Lynch

The analysts are homing in on the seeming disconnect reflected by a simultaneous rally in the stock and Treasury markets.

Read: Investors face a conundrum: Which market is wrong?

“In our view, it is difficult to see the Fed cutting by as much as markets expect, if at all, if there is a U.S.-China trade deal, and it would be difficult for equities to remain so strong if there is a trade war,” the BAML analysts wrote.

See: Why the path for stocks and other markets now depend ‘critically on politics’

Stocks have found their footing in June as expectations for Federal Reserve rate cuts have risen, reflecting apparent faith in the central bank’s ability to avert a severe economic slowdown or recession. The S&P 500 SPX, -0.17%  is up 4.8% so far in June, trading less than 3% below an all-time closing high set just before a May pullback. The index is up roughly 15% in the year-to-date, putting it on pace for its best first half since 1998, according to Dow Jones Market Data. The Dow Jones Industrial Average DJIA, -0.14%  is up around 11.6% in the year to date, gunning for its strongest first half since 2013.

Indeed, even during the May pullback, stock-market investors largely kept their cool. Jim Carney, founder of New York-based hedge fund Parplus Partners, told MarketWatch that the cost of buying “real crash protection” in the options market fell significantly since early May, appearing to reflect

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