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A week of tariff talk and capacity stress
Simply Economics - April 20, 2018
By Mark Pender, Senior Editor



The effects of March's tariffs on steel and aluminum are beginning to appear in economic reports. Some of the information is anecdotal, like that of the Federal Reserve's Beige Book which reports that price increases, some "dramatic", are being fed through to customers. And others are soft data coming from small sample regional reports where stress and price increases are clearly apparent. We'll also touch on where the first signs of tariff effects are likely to appear in the definitive economic data that are yet to be released.


The economy

In what may be an early effect of tariffs and talk of trade war, expectations in the Empire State manufacturing report have literally plummeted this month. The 6-month outlook collapsed  nearly 26 points to only 18.3 which is very weak for this reading. The last decline of this size occured in early 2016 during the brief meltdown of the Chinese stock market. Before that, the most severe fall came in reaction to 9/11 which was 17 years ago. But recovery from here will hopefully be quick, unless of course new tariff troubles emerge. Showing a less severe reaction is the expectations reading in the Philly Fed manufacturing report which nevertheless did fall more than 7 points to a 10-month low.


The Philly Fed report stands out, not so much for the decline in expectations, but the rise in selling prices which is another possible effect of tariffs. Current selling prices (light green area in graph) are up more than 9 points this month to 29.8 which is a 10-year high and an unmistakable echo of the week's Beige Book. The prospect of pass through isn't holding back expectations for future selling prices which, near 50, are at a 30-year high. And the need for pass through is an increasing one given the rise underway in input costs which are up this month to a 7-year high.


Tariff stress, that is the need to pay more and possibly stock more, is hitting manufacturers at a time when capacity is already being stretched. This is a big understatement for those manufacturers who respond to the Empire State and Philly Fed surveys and who are reporting unusually severe delays. Delivery times in the Empire report are showing the most slowing in 17 years of records while at 20.7 for Philly's delivery index, slowing is the most severe in 50 years of records.


Unusual stress is also appearing in the workweek of these surveys. Empire State's, at 16.9, is the highest in more than 10 years while the Philly Fed reading of 21.6 is the highest in 30 years. Longer deliveries and a rising workweek are consistent with diminishing capacity to meet demand. This poses the risk, at least for these samples, of inflation, something which tariffs will be adding to. Let's just step back a minute and remember that small sample surveys, like Empire and Philly, have been heating up for the last year, a bit more so than the actual manufacturing sector nationwide. But both these reports are closely watched and these records are in fact just that, records.


Another industry showing capacity issues and that will be affected by the tariffs is mining which produces the basic materials for steel and aluminum. Mining output has been taking off since President Trump's victory and it easily topped the March industrial production report at an index of 118.2. Mining volumes are rising at a double-digit pace with capacity utilization at 90.1 percent, this compared to only 75.9 percent for manufacturing. A greater need to supply domestic metals, as the metals industry shifts away from exports, is hitting mining at a very busy time. As of the March industrial production report, however, tariffs didn't have much effect though they didn't give much of a boost to construction supplies where output slipped in the month.


Metals are an important part of construction, whether for building materials or equipment. Reports of disruptions to the sector emerged immediately after the tariffs were announced in March. Any supply snags would not be welcome in housing where single-family units, which is key for the market, are in short supply. The tariffs probably didn't have much of an effect on single-family construction in March but they didn't help. Starts fell 3.7 percent in the month to an 867,000 rate while completions fell 4.7 percent to an 840,000 rate for their sharpest decline in eight months.


Another place to watch for tariff effects is the 6-month sales component of the housing market index which is produced by the nation's home builders. Rising costs and limited access to materials and equipment could begin to pull down this component which, along with other readings in the report, have already been edging lower this year. Builders are in a hurry to feed a badly under-supplied housing market and tariffs may not help. And in as much as tariffs limit the supply of homes or raise costs, customer traffic, the bottom line in the graph, may begin to struggle even more.


Despite talk of stockpiling, the jury is still out whether the tariffs tripped a measurable rise in inventories. The first indications on this will be inventory data in the coming week's durables goods report for March which tracks the manufacturing sector. Inventories at both manufacturers and especially wholesalers were already on a significant climb going into the tariffs as seen in the accompanying graph.


Another area where tariffs may have an effect, and arguably a positive one at least initially, is employment. The Beige Book noted that steel and aluminum manufacturers in the St. Louis area are reopening their facilities and calling back workers. Manufacturing payrolls have been on a solid rise but March's data didn't show any evident effects. The April employment report, where general indications aren't that favorable, will be the data highlight of the April 30 to May 4 week.


Markets: Treasury yields back in the news!

It's usually not good news when the headlines are about the bond market and not stocks. The 10-year Treasury yield has been climbing noticeably at the same time (and this may be no coincidence) that tariffs are appearing. Tariffs raise the price of imports and limit the ability of suppliers to keep prices down for their customers. What's key is not so much the steel and aluminum imports already imposed but the risk that further tariffs, both U.S. and foreign, may now be around the corner. Inflation erodes the value of bonds (at least those bonds that aren't inflation adjusted) and the less demand there is, the higher the yields go. Higher yields won't be any help for finance-sensitive sectors, especially housing, and they could mean an end to dollar depreciation as foreign investors, seeking higher yields, move into dollar assets. The 10-year Treasury yield, at 2.96 percent and a 4-year high, rose a very steep 14 basis points in the week bringing its year-to-date climb to 55 basis points with the dollar index, at 90.41 and near a 4-year low, up 0.7 percent in the week to cut its year-to-date decline to 2.0 percent.


Markets at a Glance Year-End Week Ended Week Ended Year-To-Date Weekly
2017 13-Apr-18 20-Apr-18 Change Change
DJIA 24,719.22 24,360.14 24,462.94 -1.0% 0.4%
S&P 500 2,673.61 2,656.30 2,670.14 -0.1% 0.5%
Nasdaq Composite 6,903.39 7,106.65 7,146.13 3.5% 0.6%
Crude Oil, WTI ($/barrel) $60.15 $67.31 $68.25 13.5% 1.4%
Gold (COMEX) ($/ounce) $1,305.50 $1,347.60 $1,337.80 2.5% -0.7%
Fed Funds Target 1.25 to 1.50% 1.50 to 1.75% 1.50 to 1.75% 25 bp 25 bp
2-Year Treasury Yield 1.89% 2.36% 2.46% 57 bp 10 bp
10-Year Treasury Yield 2.41% 2.82% 2.96% 55 bp 14 bp
Dollar Index 92.29 89.76 90.41 -2.0% 0.7%


The bottom line

The tariffs of March could mark the beginning of a pivotal shift in cross border trade that in turn would have effects across a wide range of domestic industries. And it's not so much their initial effects, whether primary or secondary, but the risk that the metal tariffs are only the tip of an oversized and fast approaching iceberg, at least that's the feeling one can get reading the news.


Week of April 23 to April 27

First-quarter GDP on Friday will be the highlight of a week that opens with housing data: existing home sales on Monday followed on Tuesday by new home sales and both Case-Shiller and FHFA price data. Home sales have been flat so far this year but not prices which have been getting a boost from low supply on the market. Factory data include Richmond Fed on Tuesday where the raw materials component may offer new clues on tariff effects with durable goods on Thursday expected to show continuing and important strength. Thursday data on goods trade and on inventories will offer key inputs into Friday's GDP report where a more moderate quarter is the expectation.




National Activity Index for March

Consensus Forecast: 0.29

Consensus Range: 0.20 to 0.50


Retail sales were solid in March as were building permits as well as mining and utility production which will all be positives for the national activity index. Not much of a positive, however, was a marginal rise in manufacturing production nor the slim 103,000 increase in nonfarm payrolls which will both hold back the month's results. The index is expected to come in at 0.29 vs February's very strong 0.88.


PMI Composite for April, Flash

Consensus Forecast: 54.6

Consensus Range: 53.6 to 54.8


PMI Manufacturing

Consensus Forecast: 55.0

Consensus Range: 54.3 to 56.0


PMI Services

Consensus Forecast: 54.5

Consensus Range: 53.5 to 54.8


The PMIs have been running at moderately strong rates in the mid-50s led by manufacturing but including solid strength for services. Steel tariffs could affect both price and inventory results and may show up in the report's comments. The consensus for the April flash composite is 54.6 with manufacturing seen at 55.0 and services at 54.5.


Existing Home Sales for March

Consensus Forecast, Annualized Rate: 5.528 million

Consensus Range: 5.390 to 5.800 million


At a consensus decline from a 5.540 million annualized rate to a 5.528 rate, existing home sales in March are not expected to extend February's bounce higher. Supply on the market has been well below demand and has been lifting prices and holding down sales.




Case-Shiller, 20-City Adjusted Index for February

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

Consensus Range: 0.5% to 0.7%


Case-Shiller, 20-City Unadjusted Index

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

Consensus Range: 0.1% to 0.3%


Case-Shiller, 20-City Unadjusted Index

Consensus Forecast, Year-on-Year Change: 6.2%

Consensus Range: 6.1% to 6.6%


Home price acceleration has been at a 3-1/2-year high, whether for FHFA data or the Case-Shiller 20-city adjusted index where the consensus is calling for another solid monthly gain of 0.7 percent in data for February. But the year-on-year rate is not seen moving higher, to 6.2 percent vs 6.4 percent in the prior month. The unadjusted monthly rate, at only a 0.2 percent expected gain, is a reminder that housing activity during the winter months is seasonally slow.


FHFA House Price Index for February

Consensus Forecast, Month-to-Month Change: 0.5%

Consensus Range: 0.4% to 0.8%


Growth in the FHFA house price index, which shot higher in January, is expected to slow in February to a consensus monthly gain of 0.5 percent. The year-on-year rate for this index burst over the 7 percent line in January to a 3-1/2-year high of 7.3 percent. Cities in the Pacific and Mountain states have running at or near 10 percent.


New Home Sales for March

Consensus Forecast, Annualized Rate: 630,000

Consensus Range:  610,000 to 687,000


New home sales peaked late last year but have been struggling since, held down by rising mortgage rates and limited supply. Forecasters see improvement for March, at a consensus 630,000 vs February's 618,000.


Consumer Confidence Index for April

Consensus Forecast: 127.0

Consensus Range: 123.1 to 129.0


Getting a boost from this year's tax cut, the weekly consumer comfort index and bi-monthly consumer sentiment index have been hitting expansion highs as has the monthly consumer confidence index. Consensus for April confidence is steady strength at 127.0 vs 127.7 in March.


Richmond Fed Manufacturing Index for April

Consensus Forecast: 16

Consensus Range: 14 to 20


Steady strong growth is Econoday's consensus for the Richmond Fed manufacturing index, at a consensus 16 for April vs March's 15. Watch for dislocations tied to steel tariffs including increasing prices or stockpiling in the raw materials component.




Durable Goods Orders for March

Consensus Forecast, Month-to-Month Change: 1.7%

Consensus Range: 0.1% to 4.0%


Durable Goods Orders, Ex-Transportation

Consensus Forecast: 0.5%

Consensus Range: 0.2% to 0.8%


Durable Goods Orders, Core Capital Goods (Nondefense Ex-Aircraft)

Consensus Forecast: 0.5%

Consensus Range: 0.2% to 0.9%


Giveback is not the expectation for durable goods orders which are expected to rise 1.7 percent in March following significant and broad-based strength in February. The consensus for ex-transportation orders is a 0.5 percent increase with core capital goods also expected to rise 0.5 percent.


International Trade In Goods for March

Consensus Forecast, Month-to-Month Change: -$75.0 billion

Consensus Range: -$75.9 to -$74.0 billion


The goods deficit is expected to narrow to a consensus $75.0 billion in March vs $77.0 billion in February (revised from an initial $75.4 billion). March's report will offer some of the first hints, if any, on the cross-border effects of U.S. metal tariffs.


Initial Jobless Claims for April 25 week

Consensus Forecast: 230,000

Consensus Range: 225,000 to 231,000


Initial claims are expected to come in at 230,000 in the April 25 week in what would be a 2,000 rise from the prior week. Readings have been edging higher though still solidly consistent with strong demand for labor.


Wholesale Inventories for March

Consensus Forecast, Month-to-Month Change: 0.5%

Consensus Range: 0.3% to 0.6%


Wholesale trade inventories are expected to rise 0.5 percent in March following very strong builds of 1.1 and 0.9 percent in the two prior months.




Real GDP: 1st Quarter, 1st Estimate, Annualized Rate

Consensus Forecast: 2.0%

Consensus Range: 1.3% to 2.8%


Real Consumer Spending, Annualized Rate

Consensus Forecast: 1.2%

Consensus Range: 0.7% to 2.4%


GDP Price Index

Consensus Forecast: 2.4%

Consensus Range: 2.1% to 2.5%


The first estimate for first-quarter GDP is expected to come in at a 2.0 percent annualized rate vs 2.9 percent in the fourth quarter. Residential and nonresidential investment as well as inventories look to be positives with net exports a negative. Consumer spending is expected to moderate to a 1.2 percent rate from the fourth quarter's very strong 4.0 percent. The GDP price index is seen inching higher to 2.4 percent rate.


Employment Cost Index for 1st Quarter

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

Consensus Range: 0.6% to 0.8%


Modest acceleration is expected for the employment cost index which is expected to rise 0.7 percent in the fourth quarter compared to 0.6 percent in the third quarter. This report has been at expansion highs with wages and benefits both showing similar gains.


Chicago PMI for April

Consensus Forecast: 57.9

Consensus Range: 56.8 to 58.5


Little bounce back is the consensus for the Chicago PMI report, at 57.9 in April vs 57.4 in March. Capacity stress is a question for this sample as delivery times have been lengthening and skilled workers hard to find.


Consumer Sentiment Index, Final April

Consensus Forecast: 98.0

Consensus Range: 97.0 to 102.0


Based on a dip at in the mid-month preliminary release, the consumer sentiment index for final April is expected to come in at 98.0 vs March's 14-year high of 101.4. The assessment of current conditions fell back in the preliminary report as did inflation expectations.


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