Trade Tensions Continue to Lurk in the Background

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Coffee and Economic Review

Global stocks edged high on Friday on robust earnings and consumer staples boosting Wall Street, though a trade spat between the U.S. and China and tepid U.S. employment numbers capped gains and weighed down the dollar. Market participants are still fixed on the trade dispute between the U.S. and China, which proposed new tariffs on $60 billion of U.S. goods. MCSI’s broadest gauge of stocks across the globe gained 0.22% on Friday. As for currencies, the U.S. dollar slipped against the yuan as the Chinese central bank raised reserve requirements for foreign exchange to stabilize the currency.

  The S&P extended its fifth straight weekly gain, despite rising trade tensions and a slower than expected addition of only 157,000 jobs in July. Stocks got a boost late-Friday as the White House said there were high level talks with China about trade and officials were open to more discussion. Trade maneuvering kept markets on bare feet over the week, competing with mostly positive earnings and an upbeat assessment by the Federal Reserve. China has proposed retaliatory tariffs on $60 billion worth of U.S. goods ranging from liquefied natural gas (LNG) to some aircraft on Friday, as a senior Chinese diplomat cast doubt on the prospects of talks with Washington to solve the bitter trade dispute. The trade issue is likely to linger.


U.S. data was mixed over the week. The second quarter came in strong as expected, with GDP expanding 4.1% at an annual rate. Details were generally favorable for third quarter growth. Consumption was strong and trade ahead of tariffs added a percent to growth. The fiscal stimulus will support the economy for the next few quarters, with growth projected over 3%. There are downside risks from business investment and trade. The fall-out from trade is growing. Higher inflation from tariffs is a concern. So far, financial markets are buoyed by decent earnings, but that could change as trade tensions grow.


The ISM manufacturing and non-manufacturing indexes cooled in July but both indexes are still at elevated levels. The ISM manufacturing index fell from 59.1 in June to 55.7 in July. Most sub-indexes moderated in July. Comments from respondents hinted that the recent trade environment has begun to impact activity. The ISM non-manufacturing index fell from 59.1 to 55.7. Trade was an issue, as well as transportation constraints. Vehicle sales fell from 17.3 million in June to 16.8 million, but sales remain steady under a favorable consumer environment. Employment date came in lower than expected in July but that followed two strong months. Inflation remains muted and wages are only slowly grinding higher, helping the FMOC to remain on hold at the August meeting. The committee noted the economy remains “solid” but trade tensions continue to lurk in the background. The Fed is still likely to hit twice more this year. Next week will be light on the economic calendar, with the focus on inflation.

Latest Data

The U.S. Economy:

Personal income rose by 0.4% in June, the second consecutive increase at that level. Personal spending rose 0.3% in June for a second consecutive month. Real spending was very strong for the second quarter as a whole. Supporting the spending are income gains. Nominal disposable income rose by $65.3 billion in the second quarter, better than the $56.5 billion increase in the first quarter. Still income growth is still restrained compared to past economic expansions. Still, it is enough to support spending at a decent rate. Real spending growth was up 4% for the quarter and momentum looks good for the third quarter. Inflation remains restrained, with the PCE deflator rising only 0.1% in June and 0.2% in May. On a year ago basis, the PCE deflator was up 2.2% and the core was up 1.9%. That is enough to keep the Fed on track with its gradual policy of raising rates.


Construction spending fell 1.1% in June, following a 1.3% rise in May and a 1.7% increase in April. Private construction spending was $1.02 trillion in June, down 0.4% from May but up 6.5% from a year earlier. Private residential construction spending fell 0.5% in June, but was up 8.7% from a year earlier. Spending on single-family homes fell 0.4% m/m but is still up 8.8% from a year earlier. Spending on multi-family houses fell 2.8% m/m and is up 1.8% y/y. Nonresidential construction spending fell 0.3% in June. Public spending fell 3.5% m/m, but was up 4.9% year-over-year. After accounting for a significant upward revision to May’s estimates, the drop in June construction was the largest decline in over a year. Still, construction spending is well above its level a year earlier. Public construction spending is up from a year ago, with a large increase in road and highway construction and a big decline in educational buildings.

  U.S. vehicle sales fell to an annualized rate of 16.8 million in July, down from 17.3 million in June. The decline did put July sales below the second quarter average of 17.2 million. Despite the decline, sales were essentially unchanged from a year earlier. Sales can be volatile month-to-month, but rising interest rates and lower incentive likely hurt sales in July. Car sales fell 2.5% from June to 5.32 million units, the second consecutive monthly decline. Light truck sales dropped from 11.78 million to 11.45 million in July. The share of 0% financing accounted for just 6.9% of sales in July, compared to 11.3% in July 2017. The average rate on newly financed vehicles was 5.74%, compared with 4.77% a year ago. July’s slower sales are not a trend yet because the economy is still running strong. A wild card is Trump’s tariffs on steel aluminum and steel, which have raise input costs and his proposed tariffs on imported cars. This could pull forward sales ahead of the tariff deadline. 2018 should track near 17 million, but there will be rising headwinds as interest rates rise and credit standards are being tightened.


The U.S. manufacturing sector is faring well. The ISM manufacturing index fell to 58.1 in July, down from 60.2 in June. July was the lowest reading in eight months, but the index does remain at an elevated level. July did follow two monthly increases and readings over the 60 mark are historically hard to maintain. New orders declined from 63.5 to 60.2, with sixteen industries reporting growth in new orders. Production fell from 62.3 to 58.5. Fifteen industries reported growth in production, with primary metals the only industry reporting a decline. Inventories rose from 50.3 to 53.3, with 12 industries reporting greater inventory levels. Supplier deliveries fell from 62.3 in June to 62.1 in July. Fifteen industries reported slower deliveries, with primary metals the only industry reporting faster deliveries. Employment edged forward by 0.5 to 56.5 in July. Respondents did note the tight labor market is a constraint on production. 13 out of 18 industries reported growth in employment. Two industries, primary metals and plastics manufacturing reported a decline in employment. New export orders fell from 56.3 in June to 55.3 and import orders slipped from 59 to 54.7. The prices paid index fell from 76.8 to 73.2. Tariffs are a major threat to U.S. factories. Respondents noted weaker supply deliveries and higher prices for material the Trump administration imposed tariffs on. Steel, aluminum and machinery are seeing significantly higher prices and that will take a toll on finished goods manufacturers. The tariffs on China could result in sharply higher prices and a disrupted supply chains. Certain material, such as rare-earth metals are available to U.S. producers only via Chinese imports and few countries can match their price for a variety of products. Employment is another headwind for factories. Labor shortages are a constraint for production.

  Factory orders increased 0.7% in June, following a 0.4% rise in May. Transportation orders rebounded, increasing 2.1%, but are down 6.2% from a year earlier. Aluminum and steel import tariffs have emerged as key risks to the industry. Factory shipments were down 1% from May and stands 8.4% higher than in June 2017. Core capital goods orders were positive, rising 0.2% in June, following a 0.7% rise in May. The trend in orders is strong, up 7.8% from a year earlier. Core capital goods orders were also revised up for May. Manufacturing remains healthy, but there are risks. Looking past the volatile transportation sector, the trend growth in both capital goods orders and shipments has decelerated since late last year and reflects increasing concerns about trade. The prospect of a full-blown trade war is a downside risk for the factory sector. The the possible consequences of additional broad-based tariffs on Chinese imports, has rattled financial markets. There is evidence of rising input prices may squeeze factory margins. These concerns are added to increasing signs of labor shortages. Still, the domestic side remains healthy and supportive of manufacturing activity.


The trade deficit widened to $46.3 billion in June, up from $43.2 billion in May. The goods deficit increased by $3.1 billion in June, while the services surplus held nearly steady, with a decline of $42 million. Total nominal exports declined 0.7% and the decline was broad based, impacting nearly all categories except industrial supplies. Nominal imports rose 0.6% on higher imports of consumer goods. Both exports and imports are up significantly so far year-to-date. Exports did take a step back in June, with weakness in the automotive and consumer goods exports. Food exports, particularly soybeans, held up well in June despite a significant increase in May. Soybeans make up just 3% of exports, but they accounted for 6% of total growth in exports year-to-date. Soybean exports will likely dip in next month’s report. Trade tensions are the biggest downside risks. The stronger dollar will also weigh on future exports. The dollar is up 5% year-to-date. The dollar will drive up attractiveness for imports.


The ISM non-manufacturing index dropped from 59.1 in June to 55.7 in May, the lowest reading since August 2017. This was the fourth decline in six months. The index has been volatile over the last year but does remain well above the neutral 50 mark. Details were mixed. New orders fell from 63.2 to 57. Business activity fell from 63.9 to 56.5. The ISM non-manufacturing index slipped in July suggesting slower growth, but the economy hasn’t weakened yet and the biggest hit from the fiscal stimulus is about to hit. Anecdotes were generally upbeat about the economy and its prospects. There was plenty of discussion about tariffs and global trade policy and increasing concerns about price increases due to tariffs. Retail trade noted that questions loom over the rest of the year over tariffs. Trade aside, there were discussions about railcars and truck drivers. Supply constraints will get worse as the unemployment level falls. There is little reason to expect trade and transportation issues to be solved quickly.


Payroll gains came in somewhat lower than expected in July. Employers added 157,000 jobs, following an upward revised addition of 248,000 in June and 268,000 in May. The unemployment rate edged down to 3.9% and the participation rate was unchanged at 62.9%, as household employment told a stronger story than the payroll numbers. The employment-to-population ratio reached a post-recession high of 60.5%, as household employment grew by nearly 400,000. Average hourly earnings rose 0.3%, up 2.7% year-over-year. The labor market keeps chugging along. The easing in July can be isolated to specialty store closings, seasonal factors that brought down government payrolls and some losses in financial services and transportation. There is little evidence yet, the tariffs are hurting the labor market. Payrolls will likely average near 200,000 for the reminder of the year but will hit constraints as the unemployment rate drops below 3.5%. The expansion is likely to end in 2020 as higher interest rates and deficits and trade take a toll.

Important Data Releases This Week

July PPI index will be released on Thursday, August 9 at 8:30 AM EDT. The PPI rose 0.3% in June, fed by a jump in trade services and included hikes for energy and steel and aluminum. We expect the PPI and the core to rise 0.3% in July.


July CPI index will be released on Friday, August 10 at 8:30 AM EDT. Inflation is showing up in the producer and import price reports, but the pass through has been limited to the consumer. The CPI and the core CPI is projected to rise 0.2% in July. On a year-over-year basis, the CPI is projected to have increased 2.9% and the core 2.3%.

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