Mixed Signals as Trade War Begins to Show Up in Economic Indicators The economic data this week were a mix of pre- and post-“Liberation Day” data, although the impact of tariffs and trade war considerations were evident in all the week’s reports.
Mixed Signals as Trade War Begins to Show Up in Economic Indicators The economic data this week were a mix of pre- and post-“Liberation Day” data, although the impact of tariffs and trade war considerations were evident in all the week’s reports.
There was plenty of employment data to digest this week, and broadly speaking, there is not yet hard data to support the notion that the labor market is rolling over. The 177K new jobs added in April was stronger than the 138K consensus expectation, but net revisions subtracted 58K jobs from the previously reported increases for the two months prior. We hear mixed signals from businesses in our client meetings. Some are looking to cut costs and may lay off workers to offset tariff pressure. Yet others still reference shortages of qualified labor and say memories of the pandemic-era labor scarcity remain a viable rationale not to slash their workforce, especially for what some firms see as a 'temporary' economic slowdown. For now, businesses are not hiring as many workers as they were previously, but they're not exactly laying off workers in droves yet either. Yes, initial jobless claims rose in the final week of April to the second-highest level of the past six months, but 241K claims is still a relatively benign reading . The labor market is still growing, but that growth has now slowed in three out of the past four months. Manufacturing employment fell slightly in April which was not a huge shock considering the employment component of the ISM Manufacturing Index has been in contraction for three straight months. The headline ISM fell for a third straight month to put this yardstick for American manufacturing back to around where it was in November, and production slowed to levels last seen during the height of the pandemic. The initial GDP estimate tells us economic output contracted at a 0.3% annualized pace in the first quarter, but that reflects a massive drag from trade that lopped almost five percentage points off the overall growth rate. Real final sales to domestic private purchasers, which excludes the ups and downs of trade and inventories, came in at 3.0%, which is more or less the same growth rate the economy has sustained for the past year . However, this is still not free of tariff disruption as the underlying details suggest that households and businesses are somewhat pulling forward demand to get outlays in ahead of the transition to higher prices due to tariffs. The start of this week brought an April reading that revealed a drop in April Consumer Confidence, though the details of that report showed that, while households are not overly pessimistic on current conditions, they're growing increasingly worried about the future—particularly when it comes to employment prospects and their income. Hard data on personal income and spending for March offered greater details on how consumer spending actually fared. Real personal spending shot up 0.7% in March and February's comparatively modest nominal spending growth was revised higher. In what may be the last month without meaningful tariff impact, inflation was a non-factor in March, with both headline and core inflation flat over the month. An immediately evident theme in the spending details, however, is how tariffs were already influencing consumer behavior. For example, those thinking about buying a new car, truck or SUV headed out to make that purchase in March before April tariffs had a chance to impact the sale price. The $57 billion increase in motor vehicles and parts was bigger than the increases of the next four largest categories combined. A big question surrounding the outlook is to what extent households are not just willing but able to keep spending. Income is at the root of that answer. While tariffs are stoking fears of inflation and driving optimism lower, as long as income keeps flowing, households may not be so quick to curtail spending. The wobbly fundamentals for the labor market do not provide sufficient assurance for us and explain why our forecast includes a pullback in spending later this year. ISM Services Index • Monday The April ISM Services Index will give a first look into how the services sector responded to wide-scale tariffs imposed on April 2. Service providers were increasingly unnerved in the lead up to the president’s tariff announcement, providing anecdotal evidence of mounting supply chain disruptions and price pressures. The ISM Services Index descended 2.7 points in March to a nine-month low of 50.8. A precipitous drop in the employment component drove most of the plunge; however, businesses also reported weaker growth in orders from both domestic and international purchasers. On the upside, the measure for business activity moved modestly higher, likely a reflection of strong consumer spending on services in March. We suspect that the ISM Services Index declined again in April. The scale of tariffs imposed on April 2 was much larger than anticipated by most. Even accounting for the 90-day tariff reductions and various carve-outs made since the initial announcement, the U.S. effective tariff rate is still sitting at its highest level in over 100 years. Consumer confidence is rocked, and economic uncertainty has business investment in a holding pattern. Furthermore, regional Federal Reserve Bank surveys point to weaker services sector activity in April. We forecast that the ISM Services Index slipped to 50.0 in April, which would reflect a services sector teetering on the edge of expansion and contraction. Trade Balance • Tuesday Recent trade data is littered with evidence of businesses and consumers scrambling to get ahead of tariffs. After widening to a historical high point of $130.7B in January, the trade deficit remained highly elevated at $122.7B in February. For context, the trade deficit has only broken $100B one other time in records going back to 1992 . Importers appear to have ramped up their stockpiling efforts in the month before Liberation Day. The advanced trade in goods report showed an uptick in auto and consumer goods imports in March, which is consistent with strong personal consumption expenditures. Industrial supplies imports also remained elevated ~37% above the year prior even as they clawed back slightly from prior months. The pre-tariff surge in imports lopped off 4.8 percentage points from Q1’s GDP print. A pickup in exports softened some of the blow, but net exports still exerted its largest GDP drag in history. The act of importing itself does not indicate economic weakness, just that domestic demand was stronger than domestic supply. Tariff front-loading in the first three months of the year will likely give way to softer imports in the months ahead. In March, however, we estimate that the trade deficit widened to $138.5B, which would supersede January as the widest trade gap on record. FOMC Decision • Wednesday Expectations are nearly universal that the Fed will keep its policy rate unchanged at the May meeting. Although GDP came in soft in Q1, the underlying data do not signify a lull in economic activity. Job growth is steady, business investment sturdy and strong income growth continues to propel consumer spending. That said, plenty of soft indicators are trending in worrisome directions. Stock market indices are lower and corporate bond spreads wider than when the FOMC last met in March. Consumer surveys reveal mounting economic anxiety, while surveys of businesses point to rising input cost pressures and a hesitancy to invest. With tariff policy still evolving, recent public comments place FOMC members squarely in “wait-and-see” mode while economic developments unfold. By simultaneously stoking higher prices and higher unemployment, tariffs nudge each side of the Fed's dual mandate further away from its goal. Our attention will be highly attuned to next week’s post-meeting press conference for insight into how the Committee is thinking about the balance of risks. Our hunch is, once tariffs do start to influence hard economic data, the hit to U.S. economic growth and the labor market will induce the FOMC to lower rates even in the face of higher inflation. We currently look for the first 25 bps rate cut to occur in June with a total of 125 bps of easing penciled in for this year. That said, the possibility that levies will be reduced following new trade deals or product-specific carve-outs skew risks toward later/less easing. International Review Economics Is Like a Box of Chocolates In the words of Forrest Gump, economics is like a box of chocolates, in that you sometimes don't quite know what you're going to get. Among this week's key international events, the Bank of Japan held its policy rate at 0.50%. Uncertainty around trade policy appears to be a key factor that kept BoJ policymakers on the sidelines this month, and dovish-leaning elements of the decision and updated economic forecasts suggest this rate pause may extend for a bit longer. In terms of the updated forecasts, policymakers notched up their fiscal year 2024 real GDP forecast to 0.7% from 0.5% previously, but downwardly revised their projections for FY2025 and FY2026 to 0.5% and 0.7% , respectively, citing changes in trade policy. The BoJ also revised its inflation forecast lower. In terms of underlying price pressures , the BoJ kept its fiscal year 2024 forecast unchanged at 2.7% and revised its FY2025 and FY2026 forecasts down to 2.2% and 1.7%, respectively. For FY2027, the central bank sees CPI ex-fresh food inflation at 1.9%. Even though we had previously noted the likelihood of a July rate hike, we have now recalibrated our outlook and see the BoJ hiking its policy rate by 25 bps to 0.75% at its October meeting instead. By that point, we suspect that policymakers will have more clarity around global trade policy and local growth and inflation developments, and feel comfortable tightening monetary policy further. Canada's federal election early this week saw Liberal Party leader and recently installed Prime Minister Mark Carney secure victory, although the result was much closer than expected. The Liberal Party won 169 seats, while the opposition Conservative Party won 144 seats, with Bloc Québécois and the New Democratic Party securing 22 and 7 seats, respectively. Importantly, the Liberal Party fell just short of the 172 seats needed for an outright majority, meaning Carney's government will need the support of smaller parties to pass budgets and other legislation. During the election campaign, Carney pledged increased defense and other spending, projecting deficits that were larger than those projected by the Parliamentary Budget Office's baseline. The implications of the election outcome for fiscal stimulus are mixed—the need to reach agreement with smaller parties means stimulus measures might be implemented a little later than initially envisaged, although even greater spending may be an element of those measures to secure support. Finally, in this week's most notable economic data, Canada's February GDP fell 0.2% month-over-month and, with the advance estimate for just a small GDP increase in March, Q1 GDP is expected to rise around 1.5% quarter-over-quarter annualized. That would be a slowdown from the pace of growth in Q4-2024 and also below the Bank of Canada's forecast. Overall, the election outcome does not alter our broad outlook for the Canadian economy. We expect subpar economic growth of 0.9% in 2025 and 1.0% in 2026 and expect the BoC to lower its policy rate a further 75 bps to 2.00% by the end of this year. In this week's data releases, China released its official April PMI figures, with the manufacturing PMI falling more than expected from 50.0 to 49.0, compared to a consensus forecast of 49.7. The Caixin PMI—which leans more toward small and medium-sized enterprises—fell to 50.4. Meanwhile, the non-manufacturing PMI, which covers the services and construction sectors, dropped slightly to 50.4. The lower-than-expected numbers coming out of China after Liberation Day tariffs paint a gloomier picture than Beijing may have hoped for. In consideration of these PMI readings, and what we view as a somewhat vulnerable growth environment for China going forward, we maintain our forecast for economic growth to slow to 4.1% in 2025. The Chinese economy has been trying to shift their drivers of growth to domestic consumption from being heavily reliant on trade and domestic infrastructure—a transition, however, that has not yet fully taken hold. This likely means the government will have to take other measures to mitigate the impact of the tariffs. In recent months, authorities have generally been more proactive with monetary and fiscal stimulus measures, a trend we think could continue in the months ahead. In other important data, Eurozone Q1 GDP was stronger than expected, rising 0.4% quarter-over-quarter , while holding steady at 1.2% year-over-year. Many of the region's major economies eked out only modest growth, with German GDP rising 0.2% quarter-over-quarter, French GDP rising 0.1% and Italian GDP rising 0.3%. Spanish GDP was more solid, with a gain of 0.6%. While the upside surprise to Q1 growth was a pleasant surprise, softer confidence surveys—in particular the Eurozone April PMIs—still point to weaker growth ahead. The Eurozone April CPI print was mixed. Headline inflation head steady at 2.2% year-over-year versus expectations for a modest deceleration. Perhaps more notable, some measure of underlying inflation quickened more than expected last month. Core inflation firmed to 2.7%, while services inflation quickened to 3.9%. The pickup in underlying inflation could be temporary and related to the timing of Easter. That said, somewhat firmer growth and inflation could have some implications for the path of European Central Bank monetary policy. We still expect an ECB rate cut in June, but how far and how fast the ECB eases monetary policy beyond that should depend on the extent to which Eurozone growth and inflation show renewed softening. Read Full Report!
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