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Tariffs and tax cuts, imports and inflation
Simply Economics - March 2, 2018
By Mark Pender, Senior Editor



Policy moves by the Trump administration, both tariffs and tax cuts, are beginning to shape changes in economic data. Yet one thing that has yet to change is inflation which is still subdued in a marginally climbing trend. This week we'll offer some new graphs to help inform us for the upcoming debates, whether on trade or fiscal policy.


The economy

As background on President Trump's move to impose 25 percent tariffs on imported steel and 10 percent tariffs on aluminum, it's important to consider the effect of trade on GDP -- an effect that has been deeply negative. The second estimate of fourth-quarter GDP was released in the week and showed the trade gap running at an annualized $652.6 billion during the quarter. This is a record and, if extended through the course of a year, comes out to $1.8 billion leaving U.S. shores each day for foreign accounts. This gap, compared to the pace of the third quarter, accelerated by more than $50 billion and ended up pulling down fourth-quarter GDP by 1.1 percentage points. This means that without the trade gap, the quarter's 2.5 percent overall GDP rate would have been well over 3 percent.


The week also included trade data for the month of January, specifically goods trade which is where the U.S. deficit is centered. The goods gap deepened another couple of billion dollars in the month to $74.4 billion and of course another unwanted record. Unless this is reversed by much smaller deficits in February and March, trade will once again hold down GDP, this time first-quarter GDP.


Only a small portion of the goods gap is to blame on primary metals, which is the subcomponent that the steel and aluminum tariffs would directly hit. This gap totaled $3.8 billion in the latest data for this reading which is November. But here it's important to note that this deficit isn't only one way. U.S. firms actually exported a very sizable $4.0 billion in primary metals to foreign buyers in the month as tracked in the blue columns of the graph, a sum that could be at risk should a trade battle for metals begin to open up. What the administration is of course aiming to reduce is the graph's red columns, the roughly $8 billion in monthly imports of primary metals.


But metals could just be the shot over the bow. The deepest zone for the deficit is consumer goods, this includes everything from apparel to household goods with this deficit increasingly running deeper below the $50 billion per month line, at $54.3 billion in advance data for January. Here exports make up an especially small margin, well under the $20 billion line at $18.0 billion in January. This deficit alone totaled $36.3 billion in the month. If the administration wants to cut the drag from GDP, perhaps no other target is richer than narrowing the consumer products gap.


The nation also runs a major deficit for vehicles. This gap is also lopsided against exports, at only $13.9 billion for exports in January vs $30.9 billion for imports. The balance, at minus $17.0 billion, is another rich target. Stepping back and looking at the whole of January's trade report, the results are clearly not positive. Total goods exports fell 2.2 percent in the month with total imports down 0.5 percent in a cross-border combination that hints at a slow start for 2018 global demand.


Taxes also made their appearance in the week's data. The personal taxes component of the personal income & outlays report posted a monthly decline of 3.3 percent in January. This is a rare drop last approached back in January 2016 at 2.1 percent and offers an explanation for the latest surge in consumer confidence. The drop in taxes is not only good for confidence but it's good for income as disposable income, the blue line in the graph, jumped 0.9 percent in the month. This is more than double the strength of its recent run.


And what's good for income should prove to be good for spending. The graph tracks the blue line of disposable income, this time on a year-on-year and inflation-adjusted basis, against the green line of inflation-adjusted consumer expenditures. The blue line, even before the tax cut, was on the ascent and would make a coming shift higher for the green line less than a surprise. Note that real disposable income has been supported the last two years by a very low rate of inflation. Should inflation begin to pick up, gains in nominal income would have to outstrip the inflation rate for the blue line to continue to move higher.


But inflation right now is subdued, the verdict of Federal Reserve Chairman Jerome Powell who made his debut on Capitol Hill during the week. But core inflation, as tracked by the dark blue columns, did post its highest reading, at just under 0.3 percent in January, since January last year. And though Powell also said that wage inflation isn't yet accelerating, average hourly earnings, the light columns, have been showing noticeable pressure, including December at just over 0.3 percent and just over 0.4 percent in January. Note that going out two decimal places is common for monthly inflation readings given their importance.


And there was more news on inflation, news that curiously contrasts with all the concerns in the financial markets over price pressures. Inflation expectations have yet to show any lift at all with the blue line of the consumer stuck at 2.7 percent and the green line for business holding at 1.9 percent. The pink line is the actual CPI which is stalled at 2.0 percent. Markets, that is the sum of investors, are famously believed to anticipate future shifts in the economy, but here investors appear to be anticipating a future lift that consumers and businesses have yet to concede.


The week also included updates on housing, manufacturing and the consumer, all less than inspiring. Slowing is the call for resales as the pending home sales index fell sharply and is pointing to trouble for final sales of existing homes where the year-on-year rate for January had already fallen back below the zero line to minus 4.8 percent. New home sales also disappointed in January, sinking below the zero line on a year-over-year basis to minus 1.0 percent. The rise underway in interest rates is a negative for housing as is a lack of available supply for buyers to choose from, a factor that is especially severe in the resale market.


Disappointment also hit the factory sector as the durable goods report showed wide declines throughout including for the key core capital goods group. Core orders have fallen for two straight months with shipments of capital goods visibly weaker than they were through the middle of last year. The heart of capital goods is machinery and lack of investment here will not only hold down business investment as tracked in the GDP account but will limit future productivity growth.


The first February indication on consumer spending, which has been proving soft lately, doesn't point to any new strength. Vehicle sales could not improve on a subdued January, slipping slightly to a 17.1 million annualized rate in February. Since October's hurricane-replacement boom, vehicle sales have not been showing much life, posting steep declines and significantly holding down growth in two of the last three retail sales report.


But there's one last update that does point to strength and for the most important economic indicator of all -- the monthly employment report. Initial jobless claims fell 10,000 in the February 24 week to 210,000. This was not only lower than expected but it's the best reading in 49 years. The 4-week average is at 220,500 and is trending roughly 15,000 lower than the month-ago comparison which points to increasing demand for labor. Another hint of employment strength comes from the February consumer confidence report where those who describe jobs as currently hard to get fell very sharply. However mixed housing or manufacturing or consumer spending may be, employment is not to blame.


Markets: First rate hike worries, then tariffs

The week opened with focus on Powell and whether he would hint at a fourth rate hike this year vs the three that are already expected. In his first appearance on Tuesday, Powell stressed the strengths of the economy which, whether a hint or not, raised expectations for that fourth hike. On Thursday morning Powell turned the emphasis around, that the strength is not excessive and that overheating isn't a risk. Stocks rallied Thursday morning on the comments before Trump's tariff bombshell at midday gave the market's something new to worry about. Posting major declines on Tuesday through Thursday, the Dow ended the week at 24,538 for a 3.0 percent dip on the week and a year-to-date decline of 0.7 percent.


Markets at a Glance Year-End Week Ended Week Ended Year-To-Date Weekly
2017 23-Feb-18 2-Mar-18 Change Change
DJIA 24,719.22 25,309.99 24,538.06 -0.7% -3.0%
S&P 500 2,673.61 2,747.30 2,691.25 0.7% -2.0%
Nasdaq Composite 6,903.39 7,337.39 7,257.87 5.1% -1.1%
Crude Oil, WTI ($/barrel) $60.15 $63.55 $61.46 2.2% -3.3%
Gold (COMEX) ($/ounce) $1,305.50 $1,333.30 $1,322.00 1.3% -0.8%
Fed Funds Target 1.25 to 1.50% 1.25 to 1.50% 1.25 to 1.50% 0 bp 0 bp
2-Year Treasury Yield 1.89% 2.25% 2.24% 35 bp −1 bp
10-Year Treasury Yield 2.41% 2.87% 2.86% 45 bp −1 bp
Dollar Index 92.29 89.88 89.96 -2.5% 0.1%


The bottom line

One outcome of rising tariffs is inflation, that the charges will be passed along to domestic buyers. This was actually cited by respondents to February's Chicago PMI report who blamed prior increases in imported steel tariffs for current upward pressure on input costs. And that was before any new tariffs. But for now inflation is a theoretical threat, not an immediate one. And as far as GDP goes, a very direct way to give it a major boost is to narrow the nation's import/export gap.


Week of March 5 to March 9

Strong job growth and a deeper decline in the unemployment rate are the calls for the week's highlight: Friday's employment report where nonfarm payrolls are expected to rise 205,000 and the unemployment rate is seen dipping to 4.0 percent. Despite the strength, no new pressures are expected for the report's wage data. Monday starts the week with service sector updates from the PMI and ISM reports, both of which have been showing increasing strength, followed on Tuesday by factory orders where a sizable January decline is the expectation. Trade data will be the highlight on Wednesday morning and an increasing deficit would only underscore the discussion about tariffs. Wednesday afternoon will see the Beige Book where the economic assessments have until now, at least, been very subdued.




PMI Services for February, Final

Consensus Forecast: 55.9

Consensus Range: 53.5 to 55.9


PMI services moved higher in the flash for February and are expected to hold at the 55.9 result for the final reading. New orders and business confidence showed special strength in the flash report.


ISM Non-Manufacturing Index for February

Consensus Forecast: 58.8

Consensus Range: 58.0 to 60.0


The ISM non-manufacturing index is expected to slow a bit in February, to a still hot 58.8 vs January's unusually robust 59.9. With the new orders and employment indexes both over 60, the January report was one of the very strongest on record for this sample.




Factory Orders for January

Consensus Forecast, Month-to-Month Change: -1.2%

Consensus Range: -4.3% to -0.4%


Weakness is the call for January factory orders, at a consensus decline of 1.2 percent and one based on sharp declines in advance data on the durables side of this report. And weakness was the wide result for January durables, especially for core capital goods which showed weakness in both orders and also shipments.




ADP, Private Payrolls for February

Consensus Forecast: 203,000

Consensus Range: 172,000 to 223,000


ADP got back in the win column with a January call that predicted what proved to be solid strength in the government's employment report. ADP has been running above the government's data which is reflected in the difference in Econoday's consensus calls for each, at 203,000 for ADP in February and 195,000 for private payrolls.


International Trade Balance for January

Consensus Forecast: -$55.1 billion

Consensus Range: -$56.1 to -$52.8 billion


The international trade deficit is expected to widen in January to $55.1 billion from February's already steep deficit of $53.1 billion. Advance data on the goods portion of this report showed sharp deepening with a 2.2 percent February drop in exports.


Nonfarm Productivity, 2nd Estimate, 4th Quarter

Consensus Forecast, Annualized Rate: -0.1%

Consensus Range: -0.3% to 0.7%


Unit Labor Costs

Consensus Forecast, Annualized Rate: 2.2%

Consensus Range: 2.0% to 2.5%


Fourth-quarter output did rise at a 3.2 percent annualized compared to the third quarter, but it took 3.3 percent more hours to accomplish the increase. Given the lack of revisions in the second estimate for GDP, very little change is expected for the second estimate of nonfarm productivity, at minus 0.1 percent and unchanged from the first estimate, with unit labor costs at plus 2.2 percent vs an initial 2.0 percent.


Beige Book

Prepared for the March 20 & 21 FOMC Meeting


"Modest-to-moderate" has been the battle cry of the Beige Book for the last year, including January's edition that, in contrast to the month's FOMC statement which raised the inflation outlook, described price growth as "modest-to-moderate" and downgraded the strength of the factory sector and the labor market. More recently, Jerome Powell is emphasizing the strength of the economy, something that the Fed's Beige Book has yet to do.


Consumer Credit for January

Consensus Forecast: $17.8 billion

Consensus Range: $10.0 to $19.0 billion


Another tangible rise in consumer credit is the call for January, at a consensus $17.8 billion vs $18.4 billion in December and $31.0 billion in November. Consumers have been drawing on their credit cards at a steady rate with revolving credit running at 6 percent annualized growth.




Initial Jobless Claims for March 3 week

Consensus Forecast: 220,000

Consensus Range: 215,000 to 225,000


Initial claims are expected to come in at 220,000 in the March 3 week vs 210,000 and a 49-year low in the prior week. Claims have been low and consistent with minimal layoffs and strong demand for labor.




Nonfarm Payrolls for February

Consensus Forecast: 205,000

Consensus Range: 152,000 to 230,000


Unemployment Rate

Consensus Forecast: 4.0%

Consensus Range: 4.0% to 4.1%


Private Payrolls 

Consensus Forecast: 195,000

Consensus Range: 150,000 to 216,000


Manufacturing Payrolls 

Consensus Forecast: 17,000

Consensus Range: 8,000 to 28,000


Participation Rate

Consensus Forecast: 62.7%

Consensus Range: 62.6% to 62.8%


Average Hourly Earnings

Consensus Forecast, Month-to-Month Change: 0.2%

Consensus Range: 0.1% to 0.3%


Average Hourly Earnings

Consensus Forecast, Year-on-Year Change: 2.9%

Consensus Range: 2.8% to 3.0%


Average Workweek

Consensus Forecast: 34.4 hours

Consensus Range: 34.3 to 34.4 hours


Econoday's consensus for February growth in nonfarm payrolls is 205,000 in what would be an extension of January's strength at 200,000. The unemployment rate is expected to tick down to 4.0 percent which would increasingly point to full employment and the risk of wage inflation. But wage pressures aren't the call for the February report as average hourly earnings are seen rising a modest 0.2 percent in the month with the year-on-year rate unchanged at 2.9 percent. Private payrolls are expected to rise 195,000 with manufacturing payrolls expected to increase 17,000. The workweek is seen rising 1 tenth to 34.4 hours and the labor participation rate unchanged at 62.7 percent.


Wholesale Inventories for January

Consensus Forecast, Month-to-Month Change: 0.7%

Consensus Range: 0.5% to 0.7%


January wholesale trade inventories are expected to rise 0.7 percent in line with advance data which also rose 0.7 percent. Inventory build slowed in the fourth quarter but looks to be gaining renewed steam in the first quarter.


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