ORLANDO, Florida, May 12 (Reuters) - TRADING DAY

Making sense of the forces driving global markets

By Jamie McGeever, Markets Columnist

Movin' on up

Relief and optimism coursed through world markets on Monday,

putting a fire under stocks, the dollar and bond yields as

U.S.-China tariff talks struck a surprisingly cooperative chord

and raised hopes that the worst of the global trade crisis is

over.

In my column today I look at the Fed's more cautious,

reactive approach to policymaking than many of its peers, who

are cutting interest rates. More on that below, but first, a

roundup of the main market moves.

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If you have more time to read, here are a few articles I

recommend to help you make sense of what happened in markets

today.

1. U.S. and China reach deal to temporarily slash

tariffs,

easing slump fears

2. Investors cheer U.S.-China tariff truce, but

cautious

over a final deal

3. What have China and the United States agreed to

in

Geneva?

4. Trump signs executive order to demand pharma

industry

cuts prices

5. Republicans leave many issues unresolved as they

push

Trump tax bill forward

Today's Key Market Moves

* Wall Street soars, with the Dow rising 2.8%, the S&P 500

up 3.3%

and the Nasdaq leaping 4.4%. The last two hit their highest

since early March, all three close above their 200-day moving

averages.

* Among the key global equity index gains: Hang Seng and

Hang Seng

tech up 3% and 5%, respectively; India up nearly 4%; Japan and

MSCI Asia ex-Japan up 2%.

* U.S. Treasury yields shoot higher, by as much as 13 bps at

the

short end. The 2-year yield climbs back above 4.00%.

* Gold slides nearly 3%.

* The dollar index leaps 1.4%, its best day since

the U.S.

election last November and one of its best in recent years.

Dollar/yen soars 2%.

Tariff truce a market 'game changer'

Whatever the longer-term outlook is for world trade,

economic growth and financial markets, there's little doubt that

the near-term prospects are brighter today than they were at the

end of last week.

The unexpectedly cordial and fruitful talks between the U.S.

and China in Geneva at the weekend defused trade tensions

between the world's two largest economies and dramatically

reduced the tail risks investors had priced into world markets.

Many economists on Monday raised their Chinese growth

forecasts, even though the projected stimulus from Beijing will

now probably be lower, and some upped their U.S. outlook too.

Of course, wherever U.S. import tariffs eventually settle,

they will be much higher than they were before President Donald

Trump came to power, probably still the highest in almost a

century. But relative to expectations - as recently as Friday

Trump was floating 80% tariffs on Chinese goods - the numbers

announced and the 90-day pause are unambiguously positive for

risk appetite.

The positivity is based on three broad factors - the level

of tariffs agreed upon, the willingness of both countries to

keep talking, and the signal it sends about Washington's

conciliatory approach to negotiations with other countries.

"The China tariff reprieve is a game-changer for tactical

risk," says Citi's Stuart Kaiser. "There are clearly still large

policy and economic risks, but we see no reason to stand in the

way of systematic buying."

Systematic buying was the name of the game on Monday. The

S&P 500 and Nasdaq both smashed through their 200-day moving

averages, closing above the closely-watched technical level for

the first time since late March. That proved to be a false dawn

- will this time be different?

A thaw in U.S.-Sino trade tensions is not the only reason

for investors' optimism on Monday - global geopolitical tensions

appear to be cooling on multiple fronts too.

Ukrainian President Volodymyr Zelenskiy said he is willing

to hold talks with Russian counterpart Vladimir Putin in

Istanbul later this week, a meeting Trump on Monday said he

would be willing to attend too.

The ceasefire between India and Pakistan agreed on Saturday

appears to be holding, Hamas on Monday released a U.S. hostage,

and the Kurdistan Workers Party (PKK) militant group, which has

been locked in bloody conflict with the Turkish state for more

than four decades, is disbanding and ending its armed struggle.

So, a ceasefire in the global trade war and signs of

de-escalation in actual military conflicts. Reasons for

investors to be relieved and even cheerful.

Fed tests limits of 'wait and see'

A split is emerging between the Federal Reserve and other

major central banks as they try to assess the economic impact of

the rapidly shifting global trade war.

The Fed has kept interest rates on hold in the face of

rising inflation risk, while many of its peers are cutting to

cushion the blow from the looming growth slowdown.

The Fed's cautious stance runs the risk of leaving Chair

Jerome Powell and team behind the curve once again.

With its decision last week to leave rates unchanged, the

gap between the Fed's and European Central Bank's respective

policy rates is the widest in more than two years. U.S. interest

rates have not been higher than Canada's since 1997.

Powell said last week he and his colleagues could afford to

maintain a patient policy stance because the U.S. economy was,

on the face of it, still in good shape. Growth and the labor

market are strong, and inflation is reasonably close to their 2%

target.

The costs of waiting were "fairly low", he told reporters

after the Fed left policy unchanged. "We can move quickly when

appropriate. But there's so much uncertainty ... I can't really

give you a time frame on that."

The inference here is that any economic damage from delaying

the resumption of its easing cycle - remember the Fed cut rates

100 basis points between August and December of last year - will

be neutralized by more aggressive moves later.

That may be wishful thinking.

While Powell is correct that the "hard" economic data, like

unemployment and retail sales, remains fairly healthy, "soft"

data such as sentiment surveys right now are "about as dark as

it gets," according to Moody's chief economist Mark Zandi. And

confidence has a direct impact on consumer, business, and

investor spending.

It's tough to predict exactly how strong that link is right

now, as it has weakened since the pandemic. But by the time the

Fed detects serious deterioration in the "hard" data, underlying

growth has probably already cooled meaningfully, meaning it may

be too late to prevent a recession.

EXPORTING INFLATION

To be fair to Powell, the cautious U.S. stance is more

reasonable when viewed through an inflation lens.

U.S. inflation expectations are significantly higher than

those elsewhere as consumers brace for a steep rise in prices

later this year due to incoming import tariffs. These

expectations may shift following news on Monday of a significant

de-escalation in U.S.-Sino trade tensions.

But even after trade agreements are reached, America's

average effective tariffs will still be the highest in decades.

And more than 75% of companies surveyed by the Fed have stated

they will be passing cost increases along to consumers.

And if the U.S.-China ceasefire doesn't hold, Beijing would

almost certainly redirect its shipments of cheap goods

previously bound for the U.S. to the rest of the world. All else

being equal, that would put upward pressure on inflation in the

U.S. while exerting downward pressure in other developed

economies. This may largely explain the Fed's more cautious and

reactive stance.

'EXCESSIVE UNANIMITY'

"The Fed suffers from excessive unanimity disease," says

Willem Buiter, former rate-setter at the Bank of England. He

argues that there is a tendency among central banks to be

"excessively gradualist" when it comes to changing rates. If

policymakers know their end goal, he says, they should try and

get there as quickly as possible without sparking unwanted

financial market volatility.

The trouble is the Fed doesn't have an idea of what its end

goal is because of the fog of uncertainty Trump's trade war has

created. Powell refused to definitely say which side of the

Fed's employment and inflation dual mandate he and his

colleagues consider the bigger risk to the economy.

Even in the best of times, setting policy is an uncertain

science and vulnerable to the vagaries of Milton Friedman's

"long and variable" lag.

"You never get it quite right - you're either too fast or

too slow," says Steve Dean, Chief Investment Officer at Compound

Planning.

Investors don't seem to be too worried right now about the

policy stasis, especially given the increasingly positive news

on the trade war front in recent weeks. Wall Street has fully

recovered the ground lost immediately after April 2.

And if the trade war fog clears up, the Fed will be in a

better position to act, perhaps justifying Powell's "wait and

see" approach. But we may need to wait another 90 days to find

out.

What could move markets tomorrow?

* UK employment (March)

* BoE Governor Andrew Bailey, chief economist Huw Pill speak

at

separate events

* Germany ZEW business sentiment (May)

* U.S. CPI inflation (April)

Opinions expressed are those of the author. They do not

reflect the views of Reuters News, which, under the Trust

Principles, is committed to integrity, independence, and freedom

from bias.