Trade Wars Will Have a Negative Impact

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World shares fell on Friday and were set to end the week in the red. The dollar climbed to a seven-month high, as investors braced for a list of Chinese goods targeted in a first round of announced tariffs by President Trump. The MSCI All-Country World Index, which tracks shares in 47 countries, fell 0.2% on Friday and trade in Europe was set for a weekly loss. President Trump decided to impose a tariff on $50 billion on Chinese goods and a second wave of $100 billion is being cued up. Beijing has warned that it was ready to respond. In Europe, the euro headed for the worst loss in 19 months after the ECB signaled interest rates would be left at record lows at least until mid-2019. The Federal Reserve raised rates this week by 25 basis points and signaled two more rate increases this year. This has raised concerns from investors concerning monetary conditions in emerging markets caused by the stronger dollar.


Wall Street stocks ended lower on Friday, capping a day of heavy trading with investors mostly pulling back from initial concerns over an escalating trade dispute between the U.S. and China. The Dow Jones fell 84.83 points, or 0.3% lower on Friday and ended the week 0.9% lower. The S&P lost 0.11 percent but ended the week up 0.01%. Fears of tariffs and a potential trade war have jostled U.S. stocks over the last six months, but investors seem to be taking the market in stride and getting used to the drum beat of rhetoric. Investors seem to be betting that this is just a negotiating point and not the start of a global trade war. The risk comes if Trump pushes ahead with more protectionist measures. This could spark a sell-off of stocks that could damage business and consumer confidence.


U.S. President Donald Trump announced hefty tariffs on Chinese imports and Beijing threatened to respond in kind, a move that looks set to ignite a trade war between the world’s largest economies. China has previously published a list of $50 billion on U.S. goods, including soybeans, aircraft and autos. The Trump administration’s trade policies have increased the risk that global trade tensions will multiply. This significantly increases downside risks for both the U.S. and global economies if actions continue on their present course. The direct impact of Trump’s action is not but itself, enormous. The $50 billion on Chinese imports amounts to 9% of total imports from China and 2.1% of total U.S. imports. This would only have a small effect on GDP. The impact on core inflation is about 0.1%.


The big concern is that this may be the beginning of trade barriers going up against many nations, including Canada, Mexico and the EU. Concerns about trade will intensify and will increase uncertainty in financial markets. There will be problems with supply chains. The U.S. supply chain depends on Chinese goods. Imports, not just from China, are crucial for the U.S. supply chain and broader manufacturing. Real imports matter more for domestic manufacturing than real exports. The real question is what is Trump’s goal? Will he try and negotiate a better trade balance. His stimulative policies have actually increased the trade deficit by increasing import demand. The difference here is important because a negotiated result may only hurt the economy a little. A global trade war could end in a global recession. Trade fears are already slowing Germany’s growth and with it, the EU.


With regards of our allies in Europe, japan, Canada and elsewhere, there are real dangers in engaging in anti-trade policies. Tariffs act like a tax on consumers and businesses and raise the cost of trade. By creating greater uncertainty, they also weigh on asset valuations, which could result in a broad financial market pull-back. The idea that we on a “war of each against all tactic,” which could reduce the general welfare of the entire world, including the U.S. Trade wars weaken household spending power and create greater uncertainty for businesses to invest. Nobody wins in a trade war.


The FMOC raised the target for the federal funds rate by 25 basis points from 1.75% to 2%. This was widely expected and there were no dissents at the meeting. The new Summary of Economic Projections showed modest changes for growth this year, a 2.8% gain, compared with 2.7% in March. The projection for the unemployment rate fell from 3.8% to 3.6% by the end of 2018. The Fed anticipates that the PCE will overshoot the target by 0.1% to 2.1%. The Fed anticipates four interest rate increases this year. The projection for the fed funds rate on 2020 remained at 3.4%. The long run equilibrium rate remains at 2.9%, therefore the Fed expects a overshoot of 50-basis points. The FMOC pointed out that the economy is doing well and the biggest boost from federal government stimulus is ahead of us. With two more interest rate increases on the board for this year, markets may begin betting the yield curve will invert. The Fed seems to be betting long-terms rates will increase avoiding the inversion. The Fed appeared more “hawkish” but that was expected in an economy with a low unemployment rate that is likely to get lower. The Fed feels the economy is doing well and avoided any repercussions from trade.


Last week was busy for economic data. Retail sales rose 0.8% in May, the fourth consecutive monthly gain. The consumer is looking stronger after the slow start to the year. The CPI rose 0.2% for the second consecutive month. The CPI was up 2.5% annualized in the last six months compared with 2.8% in March. Inflation is advancing but at a steady pace. This will keep the Fed on its steady course. Industrial production fell 0.1%, following a 0.9% increase in April. Manufacturing dropped 0.7%, largely because of a 6.5% decline in auto production. Part of that decline was attributable to a fire at a supplier.


After a busy week, things will calm down next week. Housing will be the primary focus. We look for housing starts to not change much between April and May. Existing home sales are projected to regain some of the decline in April. The NAHB index was likely unchanged in June. The outlook for the economy remains decent, but trade wars will have a negative impact.

Latest Data

The U.S. Economy:

The NFIB small business index rose to 107.8 in May, up from 104.8 in April. Details were generally better than in April. The net percent of respondents who thought the economy would improve in the next six months rose from 30% to 37%. Plans to increase capital expenditure rose slightly to 30% from 29%. Compensation plans were basically unchanged dropping to 20% from 21%, implying that labor supply is not an enormous issue yet. The uncertainty index fell from 80 in April to 72, a little odd given the U.S. stance on trade. The improvement in the index is good news and the index is at a record high since its inception in January 1986. Confidence indexes can be fickle moth-to-month and have little impact on real GDP in terms of timing and magnitude.


Producer prices increased more than expected in May, rising 0.5%, following a 0.1% advance in April. Energy played a large role in the May advance. Final demand goods prices rose 1% n May, largely driven by a 4.6% increase in energy prices. Final demand service prices rose 0.3%, following a 0.1% advance in the preceding month. Higher oil prices played a role in May’s inflationary advance, but that will fade in June and if OPEC opens the spigot more, prices will stay in a restrained zone. Inflation is advancing, but is still staying on trend on a restrained pace.


Consumer prices rose 0.2% in May, following an advance of the same magnitude in April. The core CPI also rose 0.2% on May. On a year ago basis, the headline CPI rose 2.7% and the core 2.2%. Food prices were unchanged and energy prices rose 0.9%. Inflation pressures are gradually developing, but there is little cause for panic. Low inflation has been a problem for years and some acceleration is welcome. Given that oil prices retreated on June, some of inflation’s fuel will diminish in the next few months. The tariffs on steel and aluminum will feed into inflationary figures, but remain relatively minor. As Trump is going ahead with tariffs on Chinese products and with the tariffs on Canada and Mexico, the inflationary impact will be much greater.


Retail sales rose 0.8% in May, the third consecutive month of decent readings, following a weak start to the year. Gains were broad-based, led by miscellaneous store retailers, building supply shops and gasoline stations. Sales fell at furniture stores and sporting goods stores. Sales excluding autos rose 0.9% and 0.8% excluding autos and gas. Sales were up 5.9% on a year-over-year basis, up from 4.8% in April. Sales have picked up since a weak beginning of the year, helped by the tax cuts. The main negative has been the weaker trend in auto sales. Sales should remain healthy going forward. Consumers will benefit from the lower gas prices in June. Stock market gains and rising house prices are also supports. There are risks to financial markets from Trump’s trade policies. Tariffs create higher prices and weaken economic growth on the domestic side. The impact of the tax cuts and additional federal government spending is just starting to work through the economy. However, interest rates are rising and that is a growing headwind for the American consumer.


Industrial production fell 0.1% in May, but that followed a 0.9% advance in April. Manufacturing was largely for the blame for weak reading, falling 0.7%. The weakness stemmed from a large 6.5% decline in the auto sector, which in part was attributable to a fire at a supplier. Autos are facing headwinds from rising interest rates and tighter lending. Tariffs could harm the industry by raising the price of key inputs. Excluding autos, manufacturing fell 0.25 in May, but that followed a 0.8% rise in April. Business equipment production fell 1.1% and has not moved since May 2017. Mining increased 1.8% and utility output rose 1.1% in May. The weakness in manufacturing may be a sign of things to come as tariffs take effect. Higher input costs and less export trade with our allies will damper production. Anecdotes from the IDM suggest tariffs are making it difficult to source materials and there are freight issues in the supply chains constraining production and delaying investment. That being said, fundamentals are still decent, but interest rates are rising. The global economy is slowing but still positive and the domestic economy is strong. This suggests decent industrial activity ahead in the near term.


The DIW economic institute has slashed its growth forecast for Germany due to a weak start and risks including concerns over Italy’s government and the escalating trade conflict with the United States. Italy’s coalition government comprises anti-establishment parties with a brief to shake up the EU and President Trump has threatened allies with hefty tariffs on car imports and the imposed metal duties. The Berlin-based DIW think tank cut its forecast for real GDP by 0.5 pf a percentage point to 1.9% this year and y 0.2% to 1.7% in 2019. The uncertain business outlook is causing companies to scale back investments and slowing export growth. The economy will remain positive because private consumption remains bullish and Germany has a highly diversified portfolio of manufacturing products for the export markets.


The OECD composite leading indicator ticked down to 99.9 in April from 100 in March. The indicator is a warning signal of easing momentum. The indicator suggests the major euro-area economies are set for a slowdown. The U.S, at 100.2 is a touch above the long-term rate. Emerging economies are poised to keep a steady pace on the broadly positive readings of Russia, Brazil and Poland. Germany’s figure shed 0.2 for a second consecutive month and stands at 100.3, down from 101 in the final three months of 2017. China added 0.2 and stands at 99.1 in April, but was still down from the 12-month average.  If trade policy follows its current course, tariffs will reduce economic growth and disrupt trade ties. This will slow U.S. growth.

Important Data Releases This Week

May housing starts will be released on Tuesday, June 19 at 10:00 AM EDT. Housing starts fell from 1.336 million in March to 1.287 million in April. We expect starts to rise to 1.291 million in May.


May existing home sales will be released on Wednesday, June 20 at 10:00 AM EDT. Existing home sales fell 2.5% in April to 5.46 million annualized, slightly below the first quarter average of 5.51 million. Existing home sales are projected to rise by 1.3% to 5.53 million in May.

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