Increased Tariffs Have Yet to Show Up in Full Force in Consumer Goods

By | June 3, 2019

Welcome to FTR’s “Monday Morning Coffee “ blog. The following article is designed to keep busy executives up to date with the latest economic data releases. Released every Monday, this blog promises to keep our clientele updated with the latest weekly economic news and developments, highlighting its impact on the transportation, freight, and equipment markets. Hopefully, this will be an informative addition to the fine body of work associated with FTR.

Overview

Coffee and Economic Review

European stocks tumbled and sovereign bonds surged on Friday as investors feared President Donald Trump’s shock threat of tariffs on Mexico risked tipping the United States into recession. This was added by news about disappointing China data added to the woes. Markets moved aggressively to price in deeper cuts by the Federal Reserve this year, while U.S. bond yields touched new lows and parts of the curve inverted further, seen as a warning sign for recession in the world’s largest economy. Trump will impose a 5% tariff from June 10, which will steadily rise to 25%, until illegal immigration across the southern border was stopped. Yields on the 10-year Treasury fell to a 20-month low of 2.17%. In Europe, the pan-European STOXX 600 dropped 1%, slumping to a three-month low.

President’s Trump’s announcement on tariffs on Mexico have rattled investors who fear that trade friction would hurt the global economy. The measures open-up a new front on trade and if implemented, are bound to trigger retaliation that would hit the heartland, the farming and industrial states. It risks of devasting economic relations with the biggest U.S. partner for goods. Mexico is heavily dependent on cross border trade and rose to the number one ranking because of Trumps trade war with China. Among companies that would be hit by the tariff include General Motors, with 14 manufacturing facilities in Mexico and an exporter of nearly 500,000 vehicles. Nissan, where exports from Mexico account for one-quarter of its U.S. vehicle sales. Ford and Honda and various suppliers to the auto industry will also be affected by the tariffs.

U.S. stocks dropped on Friday, as the S&P 500 closed out the month with the biggest May slump since 2010, after President Donald Trump’s surprise threat of tariffs on Mexico fueled fears that a trade war on multiple fronts could lead to a recession. The Dow Jones Industrial Average fell 354.84 points, or 1.41% to 24,815.04. The S&P lost 36.8 points, or 1.32% to 2,752.06. For the week, the Dow fell 3.01% and 6.69% for the month. The S&P lost 2.62% for the week and 6.58% for the month. U.S. Treasury yields fell to multi-month lows. Benchmark 10-year note yields dropped as low as 1.128 percent, the lowest since September 2017. The yield curve, as measured by the gap between the three-month and 10-year yields, remained deeply inverted. Some investors view this as a sign a recession is likely in one or two years. Adding to the downbeat mood, Beijing warned on Friday it would unveil an unprecedented hit list of “unreliable” foreign firms, as a slate of retaliatory tariffs on imported U.S. goods. Trade sector industrials declined 1.46% on Friday.

Fear around the trade war is top of the list of investors last week, prompting equity market downturns and helped instigate another inversion of the yield curve. The yield curve has been flirting with inversion over the last six months, but recent escalation of the trade war has brought fear of an imminent recession back into the front court. The inversion of a yield curve can signal investor suspicion about the pace of future growth, or if the Fed will need to cut rates. The escalating trade war has boosted uncertainty about growth, while the market has implied increased the probability of a rate cut by year’s end. Although there is no denying the fact that the yield curve has inverted prior past recessions, does it alone mean that we are heading for an impending recession? The answer to that question won’t be revealed likely for several months, but one thing is clear, the trade war remains the biggest downside risk to the expansion. Even if Trump’s actions give way to better relations with our trading partners and tariffs are eventually rolled back, they have already begun to affect global supply chains and will weigh on corporate profits. At the end of the day tariffs are higher taxes and the cost of products, even domestic products have some imported parts in it, will be going up.

Increased tariffs have yet to show up in full force in consumer goods. At 1.6% year-over-year basis in April, the core PCE was at 1.6%, below the Fed’s target. However, the core PCE did rise 0.25% in April, the largest monthly increase since October 2017. The Fed may be sitting in a hard place. A coming wave of higher prices would normally put the Fed on alert, but it also could mean lower demand. With no sign of a resolution to the China trade problems coming in sight and adding a potential blow from his policy on Mexico, the Fed might find itself in a wave of falling demand and confidence and they would likely feel compelled to cut rates. The trade escalation is coming just as economists have been projecting that the economy is slowing. The 3.1% rate of the first quarter was artificially high, prompted up by an inventory build and trade that are turning out to be a temporary boost. Downside risks are growing larger in recent weeks and the inverted yield curve might be right again.

Latest Data

The U.S. Economy:

Wholesale inventories advanced 0.7% in April after remaining unchanged in March. Retail inventories increased 0.5% in April, following a 0.3% decline in March. Inventories restarted the building process after a weak March. Wholesale durables advanced 0.7% in April after a 0.3% increase in March. Nondurable stocks increased 0.6%, following a 0.1% advance in March. One reason to add inventories was the looming threat of increased tariffs on Chinese goods imports. Despite the April advance, tariffs spell bad news for inventories. The tariffs mean higher prices and will cut into wholesale and retail margins. The ongoing trade war is bad new for wholesalers and retailers.

The nominal goods trade deficit climbed to $72.1 billion in April, up from $71.9 billion in March. Nominal goods exports fell 4.2% after a 1% gain in March. Capital goods exports slid 6.5%, following a 1.9% decline in March. Nominal goods imports dropped 2.7%, following a 1.6% gain in March. Imports fell across all categories of goods. Capital goods imports dropped 3.5%. There was little good news in the April report. Although the decline in goods net exports was small, both exports and imports slid sharply. The trade war likely drove the across-the-board decline in imports. Although the U.S. economy remains strong, Trump’s trade has increased the cost of a broad range of products. The trade headwinds have also increased sharply since April.

Personal income increased 0.5% in April, following a 0.1% advance in March. This was a welcome advance as income growth was a bit weak in the first quarter. Personal spending was unchanged, but that followed a 0.9% advance in March. The spending decrease was led by durables, including auto sales. Spending has been restrained and likely due to several factors. The stock market has been volatile and really has not moved upwards since last December. The government shutdown likely played a role and the trade uncertainty has hurt confidence. Still, with strong jobs growth and decent wage acceleration, spending is expected to hold up. The greatest risk is trade and the effect on the consumer when many of their products that come from China and Mexico suddenly see steep increases in prices.

The PCE deflator rose 0.3% in Aril, after a 0.2% rise in March. The Fed believes that the recent slowness in inflation is “transitory.” The April advance in the PCE deflator might mean the temporary phase in weak inflation may be ending. The Fed will be worried about what the trade tariffs will do to the cost of products. Whether the coming spike is temporary, or the start of a stronger wave of inflationary pressures. The current posture is correct of waiting to see what develops is correct. We could be starting to see a wave of increased prices that would imply an interest rate increase. On the other hand, we could see final demand start to stumble and that means that in order to reverse falling confidence, in that case, a rate cut might be necessary. So far, inflation has been quiet. The next few months might be interesting.

International:

Canada’s GDP increased 0.4% in the first quarter of 2019, a step up from the 0.3% advance in the final quarter of 2018. Nearly all the drag on the economy s coming from trade. Domestic demand grew an annualized 3.4% thanks to a sharp pickup in domestic demand ad nonresidential investment. Trade weighed heavily on the performance of the economy. Exports of goods and services fell4.1% at an annualized pace and imports grew 7.7%. Combined, the trade sector subtracted nearly 3.7 percentage points from the annualized GDP figure. Ignoring trade, final domestic demand increased 3.45 annualized rate. Housing starts were down 6.1%. That followed a steep 10.4% fall in starts in the final quarter of 2018. The outlook for Canada is decent as the drag from trade should slow. The biggest risk is global trade tensions, which are slowing the global economy.

Important Data Releases This Week

May ISM manufacturing index will be released on Monday, June 3 at 10:00 AM EDT. The index is expected to improve only slightly in May, rising to 52.9, up from 52.8 in April.

April construction spending will be released on Monday, June 3 at 10:00 AM EDT. We project construction spending to rise 0.5% in April, not quite offsetting the 0.9% decline in March.

May motor vehicle sales will be released on Tuesday, June 4 at 4:00 PM EDT. We project that ales will climb a little to 16.9 million in May, after the weak 16.4 million reading in April.

April factory orders will be released on Tuesday, June 4 at 10:00 AM EDT. The advance reading of the durables report showed factory orders falling 2.1% although ex-transportation orders were unchanged. We see factory orders falling 0.9%.

May ISM non-manufacturing index will be released on Wednesday, June 5 at 10:00 AM EDT.  will be released on Friday, May 31 at 8:30 AM EDT. Steady strength is projected for the service sector. The ISM non-manufacturing index is projected to rise to 55.7 from April’s 55.5 reading.

April international trade will be released on Thursday, June 6 at 8:30 AM EDT. Th deficit is projected to be slightly wider at $50.7 billion, up from $50.0 billion in March.

May employment situation will be released on Friday, June 7 at 8:30 AM EDT. We expect May payrolls to grow by 180,000, down from the strong 263,000 in Aril. Average hourly earnings will increase by 0.3%, up 3.2% for the year. The unemployment rate will be 3.7%, up a tick from 3.6% in April.


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About Steve Graham

Steve is one of the premier analysts in the transportation equipment industry. On a monthly basis Steve tracks and analyzes in detail the trailer and heavy-duty truck industry. Aside from following these two sectors he is also instrumental in helping our customers analyze the economy and its impact on transportation and transportation equipment.

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