There Are Some Upside Potential Due to the Tax Cuts and Fiscal Stimulus

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Coffee and Economic Review

World stocks and commodities rose on Friday, with stocks posed to post their biggest gain in over a month as investors took heart from further signs of trade tensions easing. A week after escalating tensions with his threat to impose tariffs on an additional $100 billon in Chinese products Trump said Thursday the two countries ultimately may end up levying no new tariffs on each other. Traders turned their focus on earnings season, with financial firms posting some big gains. MCSI’s broadest index of Asia-pacific shares outside of Japan edged up 0.2% on Friday, but was up about 2% for the week. The Stoxx Europe 600 Index gained 0.2% on Friday, the highest in more than six weeks. All three major U.S. stock indexes closed lower on Friday. The spread between the ten-and-two year yield narrowed by 3 basis points to 45 basis points, a new low for the cycle.


The headline CPI fell 0.1% in March, held back by falling energy prices. The core CPI rose 0.2% for a second consecutive month. Producer prices rose 0.3% and excluding food and energy, core goods rose 0.3%. Despite the March weakness in the headline number, inflation is gradually gaining ground. This will keep the fed on track for its projected three rate increases this year. The NFIB small business 9ndex fell from 107.6 in February to 104.7 in March. Despite the decline, the index remains elevated.


There were few surprises in the minutes from the Federal Open Market Committee’s March meeting. The minutes continued the message that gradual rate hikes are warranted, which has been the message for several years. There was discussion of fiscal stimulus, which participants though would boost growth over the next few years, but there was considerable uncertainty in both the timing and magnitude of the impact on GDP and employment. The members of the committee don’t believe the steel and aluminum tariffs will pose a significant impact on the country but noted that the potential of retaliatory actions by other countries do pose a downside risk to the U.S. economy. The Fed will likely stick to its three projected rate increases this year.


Trade tensions have cooled a bit in the last week, but uncertainty will remain high and have a negative impact on global financial markets. Moody’s estimate of an all-out trade war is low at 5%, but is that comes to fruition, the economic consequences are serious. Under their trade war scenario, the U.S. increases tariffs on steel and aluminum and steel and Chinese imports. There are also increases in tariffs by most of our trading partners affected by the U.S tariffs. The increase trade tensions cause NAFTS to break down, with Canada and Mexico reverting to WTO rules. The impact would cause most of the world to raise tariffs by about 10%. In this scenario, the Chinese devalue the yuan by about 10%, offsetting a big part of the impact of the higher U.S. tariffs. Other nations that trade with China also devalue their currencies by about 10%. The end result is that the U.S. economy enters recession in the first half of 2019 and GDP falls by about 2.5% and 3.5 million jobs are lost. Global GDP slows by 1.5%. The economies of Canada, Saudi Arabia, Germany, and Japan are the hardest hit. We hope sincerely that cooler heads will prevail in coming months, but since trade relationships and negotiations take a lengthy time to work out details, uncertainty will remain high.


Next week will be fairly busy for economic data. Retail sales will give us a look to see if the consumer bounces back after a slow start to the year. Housing confidence and starts will be a main feature next week, as well as industrial production and some insight from the Beige Book. The economy continues to March forward. There are some upside potential due to the tax cuts and fiscal stimulus. The timing and magnitude of the stimulus is debatable, according to members of the FMOC. With an economy already running full-tilt, stimulus efforts don’t have the same punch as when an economy is emerging from recession. While the stimulus is positive, it may not move GDP growth all that much. On the negative side, there is a heightened level of anxiety surrounding a potential trade war with China. The Fed would likely view price increases coming from tariffs as a one-time event and won’t change their rate track. However, the idea of trade barriers emerging across the globe has scary repercussions. Moody’s warns that such an event would reduce global growth in half and result in a recession in the U.S. We hope cooler heads prevail in coming months.

Latest Data

The U.S. Economy:

The NFIB small business confidence index fell in March to 104.7 from 107.6, but remains at an elevated level. The index has a history of falling in March having done so every year since 2005 but one. Details were mixed. Expectations for the economy fell from 43% to 32%. Hiring plans remained little changed. Plans for compensation hit the lowest point since November 2017. A net 28% of respondents said now was a good time to expand business, down from 32% in February. The index remains at a high level. Some measurements of the economy slowed in the first quarter and could be pointing to more modest growth. However, the expansion remains on track and may well accelerate in the next two quarters.


Producer prices increased 0.3% in March, following a 0.2% rise in February. Final demand services accounted for 70% of the March increase. Both goods and services rose 0.3%. Excluding food, energy and trade, the PPI rose 0.4% for the third consecutive month, up 2.9% from a year earlier. The PPI suggests that inflation is advancing and the Fed will stick with its plan to raise interest rates three times this year.


Consumer prices fell 0.1% in March, following a 0.2% advance in February. Energy prices were a drag and gasoline prices fell 4.9%. Food prices were tame, rising only 0.1%. Excluding food and energy, the core CPI rose 0.2% for a second consecutive month. The CPI shouldn’t alter the Fed’s plan on interest rates. The bond market assigns a 10% to 12% probability that U.S. headline inflation will average 3% or above over the next five years, close to the low for this cycle. There are concerns that tariffs will boost inflation. The Fed seems to feel such circumstances will result on a one-off increases, not a sustainable trend for inflation. The Fed does feel that tariffs could have other macro-economic effects such as lowering equity prices, which could damage growth.


Import prices were unchanged in March, following a 0.3% increase in February. Imported fuel prices drove the headline number down, with the largest decline since June 2017. Nonfuel import prices rose 0.2% in March. Import prices are still up 5.9% at an annualized pace in the first quarter, among the highest since 2011. Prices are expected to get a boost from the tariffs imposed on steel and aluminum. Users of steel and aluminum will be the primary losers from the tariffs. Energy prices will still be a primary driver of imported prices in the short run until some timing is ascertained for the proposed tariffs on Chinese goods.


China’s trade surplus with the U.S. surged nearly 20% in the first quarter, with some analysts speculating that exporters were rushing out shipments to get ahead of threatened tariffs that are spurring fears of a full-blown trade war. Even as China’s trade surplus with the rest of the world narrowed in the first three months, the surplus with the U.S. surged 19.4% to $58.25 billion from a year earlier. China’s exports rose 14.8% in the first quarter from a year earlier, while imports from the U.S. rose 8.9%. China’s exports rode a global boom last year, expanding at the fastest pace since 2013. The threatened tariffs have clouded the outlook for trade with the U.S.

Important Data Releases This Week

March retail sales will be released on Monday, April 16 at 8:30 AM EDT. Retail sales fell 0.1% in February, but there were some special concerns, including delayed tax refunds. Sales are projected to advance 0.4% in March and it will be interesting to see if spending rebounds from the weak start of the year. Consumption was strong in the fourth quarter, so a first quarter let-down is viewed as normal. Consumer fundamentals remain strong, so spending should pick up in the second quarter


February business inventories will be released Monday, April 16 on at 10:00 AM EDT. Business inventory growth has been solid, rising 0.6% in January. Stockpiles are expected to also rise 0.6% in February.


March industrial production will be released on Tuesday, April 17 at 8:30 AM EDT. Industrial production rose 1.1% in February. Manufacturing rose 1.2%, offsetting the January weakness. We expect total IP to only rise 0.3% in March and manufacturing to remain unchanged. The industrial economy is showing strength, but tariffs are a threat to future output.


March housing starts will be released on Thursday, April 19 at 10:00 AM EDT. Housing starts should make a modest rebound in March, rising to 1.248 million from February’s 1.236 million. There may be a modest drag from the snow storms in the Northeast. Permits should rise modestly from 1.298 million to 1.315 million.

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