U.S.-China trade negotiations hit a major speedbump earlier in the month and there is now a higher probability that talks could face protracted delays. President Trump stated that the U.S. is “not ready to make a deal”, though he still believes the two nations will ultimately reach an agreement.

In other trade news, just as the U.S. and Mexico took steps this week to ratify the USMCA, President Trump threatened to impose a 5% tariff on all Mexican imports starting July 10th. The President wants Mexico to do more to deter illegal migration from Central America. These tariffs, alongside prolonged Chinese negotiations, complicate trade relations even further. The heightened bout of uncertainty is likely to dent already shaky business confidence.

China has responded to U.S. rhetoric with both direct and indirect threats. The country suggested that they too may influence global supply chains through their dominance of “rare earth” exports – a group of 17 minerals used in the production of most modern electronic devices. A ban on exports to the U.S. could disrupt production and affect prices of many products ranging from smartphones to satellites. There are also indications that China may have once again halted purchases of U.S. soybeans after previously resuming purchases as a sign of goodwill during negotiations.

Meanwhile, on the domestic data front, home price appreciation continues to moderate. Data for March showed that home prices grew 3.7% year-on-year, lower than the 3.9% recorded in February (Chart 1). Price growth has been decelerating since April last year, suggesting that even with lower mortgage rates and rising wages, past price growth may have stretched affordability for many potential buyers.

First quarter real GDP growth was revised to 3.1% annualized, relative to 3.2% previously. The slight downgrade reflected lower business and residential investment. Weak performance in these two categories is expected to continue, weighing on growth in Q2 and resulting in a sub 2% outturn. Personal spending in April was also soft at 0.3% month-on-month, even as incomes rose more than expected, coming in at 0.5%. April’s outturn, however, followed strong growth in March, suggesting that personal spending will be a key driver of Q2 growth, even as other components such as investment look to drag on activity.

Global markets returned to a pessimistic mood this week, focusing on negative headlines about U.S.-China trade relations. Oil prices fell sharply on the week, as rising inventories in the U.S. had markets worried that trade uncertainty is dampening demand. Measures of manufacturing confidence across various regions were also weak. Manufacturing activity in Europe and Japan continued to contract. In the U.S., the Markit gauge of manufacturing confidence also showed a further deterioration in May.

To top it all off the Brexit saga came back to the fore, as Prime Minister Theresa May announced her resignation. May had been unable to get her negotiated Brexit deal through parliament. The way forward on Brexit remains unclear, and the new Conservative leader, who should be selected by the end of July, will not have a lot of time to chart a new course before the Oct 31st deadline for Britain to leave the EU. In the meantime, the cloud of uncertainty continues to hang over the UK economy, and the increased probability of a no-deal Brexit has weighed heavily on the pound over the past week.

The sour news continued with the April durable goods orders report, which showed total orders fell 2.1% in April. Nondefense capital goods orders ex-aircraft – a closely watched gauge of business capital spending – was also down in April (-0.9%). Durable goods orders are quite volatile month-to-month, but on a trend basis (the six month moving average) orders have gone sideways at best since late 2018 (Chart 1). This is consistent with the theme discussed in last week’s Bottom Line, that cracks continue to appear in the US manufacturing sector: foreign demand has cooled, and uncertainty on the trade front weighs on business sentiment and willingness to spend on new equipment.

The President has recognized the impact trade conflicts are having on at least one sector of the economy. He formally announced a $16 billion aid package for farmers hurt by Chinese retaliatory tariffs on key agricultural exports from the U.S. This amount is slightly larger than last year’s aid package (around $12 billion). The combined cost of these packages more than outweighs the increase in customs duties the U.S. has collected since the Administration started ratcheting up import tariffs early in 2018 (Chart 2), erasing any fiscal benefits of the tariffs.

Amidst the headlines on ongoing trade tensions between the world’s largest economies, the minutes from the most recent FOMC meeting already seemed a bit stale. These deliberations occurred before the latest increase in the tariff rate on certain Chinese imports. The minutes showed the FOMC’s commitment to patient monetary policy, and a significant discussion on whether the recent softness in inflation is transitory, or a more persistent trend. The Committee is clearly divided on that topic, and a couple more months of data is likely to settle the debate. Inflation aside, given a building cloud of global economic uncertainty, a prolonged pause on rates seems a wise course of action.

Leslie Preston, Senior Economist | 416-983-7053

U.S. equity markets managed to shrug off much of last week’s losses after rumors earlier this week, confirmed by the White House this morning, that the U.S. administration would delay a decision on auto tariffs for six months. However, this somewhat-renewed sense of optimism in equities was not shared by the bond market. U.S. Treasury yields hit lows last seen in late 2017, just prior to fiscal stimulus being announced. Moreover, markets are raising their bets that the Fed’s next move will likely be a rate cut rather than a rate hike.

Unease about U.S. economic performance is building for good reason. Economic growth is set to moderate this year after a blowout, stimulus-fueled 2018. Foreign demand remains weaker than last year, while geopolitical risks and trade policy uncertainty appear to be on the rise. Moreover, high frequency indicators are beginning to diverge. Domestic demand remains resilient, but externally oriented industries are combatting stronger headwinds.

Data for retail sales and housing starts for April support the view that the domestic economy remains healthy. Although retail sales pulled back in April, this came after a very strong March. Some payback was to be expected. Even with the decline, the strength in March, alongside continued income gains supports a very healthy 3% quarterly annualized rate of expansion in consumer spending in the second quarter (Chart 1).

Housing starts, on the other hand, surprised to the upside. After December’s dip, housing starts appear to have regained stronger footing, but activity has been choppy through April. Home builder sentiment is improving as well, reaching a 7-month high in May. Moderating home price growth, combined with lower mortgage rates, rising wage growth, and decades-low vacancy rates should support more homebuilding in the months to come.

All told, the data this week remains consistent with our forecast for the U.S. economy to expand at a 2% annualized pace this quarter, largely on the back of a more confident consumer. That said, signs continue to build that this may be as good as things get for the rest of this year. Cracks are beginning to appear in what was previously a very resilient manufacturing sector. Industrial production contracted 0.5% in April, the third contraction monthly contraction this year. This mirrors the declining pace of output reported in the ISM manufacturing survey (Chart 2). Softer auto sales are partly to blame, as motor vehicle assemblies have fallen 12.8% since December’s peak.

Although manufacturing is a relatively small share of the U.S. economy (about 11%), its performance is still considered a harbinger of the direction of the U.S. economy largely due to its sensitivity to changes in foreign demand. On that front, there are some signs that the global economy is gradually improving. However, escalating trade and geopolitical risks threaten to derail this nascent recovery.

Fotios Raptis, Senior Economist | 416-982-2556

With few data releases, the return of U.S.-China trade tensions captured attention. Financial markets were volatile, but largely down as President Trump tweeted over the weekend that an increase to tariffs on Chinese imports would go into effect Friday. These sentiments were reiterated by other high-ranking U.S. trade officials who accused Beijing of reneging on its promises in earlier negotiations. This rhetoric threatened to derail planned high-level talks with Chinese negotiators; however the Chinese delegation only delayed the meetings rather than cancelling them.

The U.S. administration officially implemented the tariff increase from 10% to 25% on approximately $200bn worth of Chinese imports on Friday. Additionally, President Trump has tweeted that he plans to levy the new 25% tariff on a further $325bn worth of Chinese goods “shortly”, a move that would cover virtually all U.S. imports from China. Even as China urged the U.S. to meet them halfway, they announced that countermeasures will be implemented, although specific details have not been revealed.

Despite the new developments, talks continued on Friday as the two sides try to salvage a deal. A sticking point for the U.S., however, is whether China will agree to implement legal changes so as to facilitate the trade deal and to make the details public. China has resisted this push, insisting that it impinges on their national sovereignty.

The new tariffs will result in a more significant drag on growth if they are sustained, impacting not only capital expenditure and consumer spending but also confidence. In a recent note, we estimate that U.S. growth could be lowered by -0.1% to -0.3% with the higher tariff. Growth could fall by as much as -0.6% if the threatened $325bn becomes a reality. The run-up in inventories witnessed in prior months partially reflected preparation by businesses for this possibility, and with additional tariffs to take effect, they are likely to pass on price increases to consumers.

To date, inflationary pressures have been benign. Consumer prices in April rose 0.3% over the previous month and were up 2% year-on-year (Chart 1). However, the threatened escalation in tariffs could see inflationary pressures firm up. We estimate that consumer prices rose by 0.3ppts from tariffs already imposed and could rise by an additional 0.4ppts if the remaining $325bn of Chinese imports are made subject to 25% tariff (see note).

Despite the U.S.’s heavy use of tariffs to rebalance trade flows, their trade deficit edged up in March, reflecting the difficulties inherent in attempting to redirect international trade. Of note, the merchandise trade deficit with China, a special area of interest, has been declining for the past few months, and hit a five year low in March (Chart 2). This development may positively impact ongoing negotiations between the two economic powerhouses. All told, the U.S. and Chinese economies are at an important juncture. Decisions made now are likely to have significant implications for the global economic landscape in the future.

Shernette McLeod, Economist | 416-415-0413

It was a busy week for those keeping a careful watch on the U.S. economy. A volley of first-tier economic data and an FOMC rate decision took center stage, while trade developments reverberated in the background.

While the consumer had a soft showing overall in the first quarter, a two-month data dump this week provided added detail on recent momentum. Real consumer spending was flat in February, before surging 0.7% in March. This spending upswing points to consumers shaking off the adverse effects of the prolonged government shutdown, and provides a solid handoff to consumption in the second-quarter.

The (mostly) positive narrative on consumer-related industries at the start of spring was further bolstered by a 3.8% m/m surge in pending home sales in March and a pickup in consumer confidence in April. The former leads existing home sales by 1-2 months, and points to further stabilization in the housing market. However, vehicle sales were disappointing, falling 6% m/m in April to 16.4M units. Despite this, overall consumer spending is still tracking a 3% annualized pace in the second quarter, a sharp acceleration from the 1.2% clip in the first quarter. This will provide support to overall economic activity as other temporary factors that boosted growth in the first quarter fall off.

Healthy consumer spending is being supported by a strong labor market. Payrolls rose 263k in April, beating expectations (190k) once again (Chart 1). The jobless rate moved down to a near-50 year low of 3.6%. However, that was driven by a disappointing decline in the labor force participation rate. Wage growth held steady at 3.2% y/y. But with softer inflation (see Chart 2), wage gains look even better in real terms. Given the current tightness, we expect wage pressures to remain, but job gains to slow to a more sustainable sub-150k per month through the remainder of 2019.

Rounding out the April data reports were the ISM indices. Both moderated on the month but continue to hover around the 55-point mark, which is in tune with the broader narrative of slower, but still decent, growth this year.

With the labor market and economic growth not looking too shabby, inflation remains the Fed’s key concern and main reason for holding rates steady, as it did this week. The FOMC statement emphasized that inflation has run below target. But in the press conference, Fed Chair Powell noted that inflation was driven down by “transient” factors, adding that there is currently no strong case “for moving in either direction”. We agree with the Fed’s assessment. Given that inflation has persistently undershot the Fed’s target, it would take a notable acceleration in price pressures to push the Fed to hike. We do not expect inflation to accelerate that quickly, and all of the latest data support our view that the Fed is likely to remain on hold for quite some time.

Admir Kolaj, Economist | 416-944-6318

The The U.S. economy brushed off disruptions caused by the partial government shutdown and abnormal weather, and grew strongly in the first quarter, beating consensus expectations by 0.9 percentage points (3.2% vs 2.3%). However, behind the sheen of the solid headline, the drivers of growth were not as lustrous. Domestic demand growth weakened, with consumers saving a little more and businesses slightly more cautious with their investments dollars. Instead, inventories and net exports – the more volatile components of GDP –provided the heavy lifting. The build-up of inventories is now a three quarter trend. It is likely to be reversed in the quarters ahead, dragging on real GDP growth. The good news is that with temporary disruptions dissipating, domestic demand should improve next quarter, taking the mantle in driving growth.

With affordability improving – a function of both lower mortgage rates and accelerating income growth – the demand drivers for housing appears to be solid. The supply side appears to be the constraining factor. The inventory of existing homes available for sale continues to hover near historical lows. Unless supply constraints are alleviated, the upswing in demand could reverse the recent deceleration home price growth.

Speaking of prices, PCE inflation data for 19Q1 was released alongside GDP data and came in surprisingly soft. We cannot yet tell which month the weakness was concentrated as only January data are available (February and March data will only be released on Monday). Nevertheless, the weaker reading in Q1 indicates cooling price pressures, reinforcing the Federal Reserve’s position to hold off any interest rate hikes through 2019. Bond yields appear to have dipped lower following the digestion of these details, discounting the surprise in real GDP growth.

Headline inflation is likely to see something of a lift in upcoming months, reflecting the broad-based rebound in oil prices since the end of 2018. Still, the ride may be bumpy. The West Texas Intermediate oil price benchmark hit $65 earlier in the week, before falling on Friday on word that Trump has been upping the pressure on OPEC. This, despite news that the administration will no longer exempt countries from Iran sanctions beginning May 2nd.

The U.S. economy had a tough winter. A government shutdown, stock market rout, and some bad weather patterns weighed on activity. The good news is that spring is coming.

The first estimate of Q1 economic growth will be released next week. The story is likely to be muddy. Headline GDP is forecast to post a reassuring 2.6% print, but that hides a much softer picture for domestic demand (1.7%, annualized). The combination of an inventory build and a decline in imports is forecast to add nearly a percentage point to growth (Chart 1). Domestic demand, meanwhile, was held back by weakness in both consumer spending (+1.2%) and business investment (+1.6%).

Soft consumer spending is likely to prove temporary. The combination of plummeting stock markets, government shutdown, and bad weather helped send consumers into hibernation at the end of 2018 and early 2019. But, March retail sales showed consumers awakening from their slumber, enough to lift consumer spending to roughly 2 ½% in the second quarter.

Headline retail sales rebounded 1.7% in March, after falling in three of the last four months. That was a bit stronger than we had anticipated, and it lifted our tracking for growth in the first quarter by 0.2 percentage points. Strength was broad based. Sales at motor vehicle dealers were up sharply, as expected, and in line with the bounce reported in unit sales.

Retail weakness had stood out against stronger fundamentals in terms of income growth, low unemployment and confidence surveys. That said, the 3%-plus readings on real consumer spending we saw last year are behind us. We expect continued solid quarterly growth in outlays in the 2-2.5% range for the remainder of the year. This downshift in growth is apparent in the smoothed year-on-year growth in retail sales (Chart 2).

The Fed’s latest Beige Book – its qualitative snapshot of the U.S. economy – reinforces this view of the economy slowing from last year’s pace, but still growing solidly. Labor markets were characterized as tight, restraining hiring growth in some regions. Some weakness is evident in manufacturing, consistent with weaker demand from abroad. Trade uncertainty restrained expansions in some districts. The clouds hovering over the global outlook have not cleared, despite a better-than-expected first quarter growth report out of China.

Trade peace with China and Europe would certainly help global sentiment. China and U.S. negotiators plan two more rounds of face-to-face talks, and are working towards a signing ceremony in late May/early June. It remains to be seen whether a deal lifts the tariffs already in place, or if these are kept on as an incentive for compliance. If they are lifted, it would provide a tailwind to Chinese, and likely global, growth.

Leslie Preston, Senior Economist | 416-983-7053

The U.S. economy continues to enjoy its Goldilocks moment – at least with respect to inflation. Consumer prices rose 1.9% year-on-year in March, up from 1.5% in February, largely driven by increases in energy prices (Chart 1). Core inflation came in at 2.0%, and while not the Fed’s preferred metric, is consistent with price pressures running neither ‘too high’ nor ‘too low’.

Several months of muted inflation readings have strengthened the Fed’s decision to keep rates where they are. Minutes of the March meeting showed that board members saw little in the data to prompt a shift in policy. This rhetoric is expected to continue through the end of 2019, with signs of an improving labor market balanced against risks to growth from a struggling global economy. The Fed’s European counterpart (the ECB) on the other hand, while leaving rates unchanged this week, signaled that there could be substantive changes to monetary policy at their next meeting in June. With anemic growth among member countries and lingering policy uncertainty, it signalled a willingness to act to ensure a return of inflation to target and bolster the region’s faltering growth.

On the trade front, relations with China seem to have taken a turn for the better, with talks between high-level officials ongoing. As cooler heads prevail in one trade negotiation however, disputes are heating up in another. The U.S. is threatening to impose tariffs on approximately $11 billion of EU imports. The threat comes after 14 years of litigation at the WTO over subsidies for European aircraft manufacturer Airbus, which America argues puts U.S. based Boeing at a disadvantage. The U.S. emphasizes that this move is independent of current ongoing trade talks with the bloc; but the timing could be seen as an attempt to gain leverage in those negotiations.

Boeing for its part continues to deal with fallout from the grounding of its 737 MAX airliners. There were no commercial orders for the product in March, the first time this has occurred since May 2012. Boeing will reduce production of the jet starting mid-April, while it works to fix flaws with the model which resulted in two fatal crashes. If the production cut lasts to the end of the quarter, they could shave 0.1 to 0.2 percentage points off Q2 GDP growth.

Internationally, Britain’s attempt to leave the EU continues to push past deadlines. This week the EU granted another flexible extension to October 31st for the UK parliament to agree to a deal. The gesture, however, came with strings attached, as the UK will have to hold EU parliamentary elections if they have not ratified the deal by the end of May or risk exiting without a deal on June 1st.

Given these and other uncertainties, the IMF downgraded projections for global growth in 2019 to 3.3%, citing ongoing trade tensions and declining confidence (Chart 2). This brings their forecast in line with our own view published in March. Growth in 2020 is expected to rebound to 3.6%, slightly above our expectation for 3.5% growth.

Shernette McLeod, Economist | 416-415-0413

Progress on U.S.-China trade negotiations helped support risk appetite in financial markets this week. Major U.S. stock indices, such as the S&P 500 – up 2% on the week – had a strong run. As money flowed into equities, Treasuries sold off, boosting bond yields, particularly for longer maturities. This helped keep the spread between long-term and short-term yields in positive territory, easing some of last week’s anxiety about any recession signal from the yield curve’s inversion.

Economic data, though not entirely positive, was broadly supportive. February retail sales undershot market expectations, falling by 0.2% m/m, instead of rising by a commensurate amount. The miss on the sign in the headline print seemed like a cruel April Fools’ joke. But, the hefty upward revision to January mitigates the downside to 19Q1 spending (Chart 1). Proving more constructive was a strong bounce-back in auto sales in March to 17.5 million, after two consecutive monthly declines. But, even with a decent showing in March, first-quarter consumption growth is unlikely to surpass 1% annualized. This soft performance is really no surprise given the drag from ‘residual seasonality’ and the government shutdown.

Lower interest rates and a steady Fed, together with a robust labor market, should continue to shore up spending in the months ahead. On the employment front, the payrolls report did not disappoint, with job gains making a comeback in March (Chart 2). The economy added 196k new jobs last month, while the unemployment rate managed to hold on to a low 3.8%. In addition, the prior two months of data were revised up by 14k combined. Other details were less rosy, such as the participation rate ticking down 0.2 ppts to 63% and wage growth easing a touch.

The March jobs data confirms that the weak February print was but a speed bump. That said, we still expect a tightening labor market to curtail the pace of job gains to below 150k per month on average through the remainder of 2019. This is slower than last year, but still decent – a theme that aligns with the broader economic narrative of GDP growth slowing to just above 2% this year.

The recent performance of manufacturing and service industries  supports this view. The ISM indices have decelerated on a trend basis from last year’s highs, but both remain well in expansionary territory. In March, the two indices diverged, with the non-manufacturing index undershooting expectations (-3.6 points to 56.1) and the manufacturing index surprising on the upside (+1.1 points to 55.3). Still, both signal an economy expanding at a healthy pace.

The resilience of the U.S. manufacturing sector has been remarkable, given the slump in activity elsewhere. Although manufacturing  improved in China and a few regional partners in March, it remained in contraction in the Euro Area. The Old Continent is going through a rough patch, and, with economic growth expected to clock in at a low 1.3% this year, it remains a source of downside risk to the global economic outlook (see here).

Admir Kolaj, Economist | 416-944-6318

Hang on to your hats folks. With Fed speeches, Brexit votes, and a slew of economic data, this week was exhilarating.

First, on the data front, the American economy expanded by 2.2% (annualized) in 2018Q4, down from the 2.6% rate initially reported (Chart 1). The revision brought annual average growth to 2.9%, though Q4/Q4 growth was 3%. Consumer spending, government expenditure and business investment were all revised lower, while net exports showed a smaller deficit. Corporate profits also stalled in Q4. These data point to a slowing trend and a weaker handoff to 2019. Reinforcing this narrative, personal income and spending kicked off 2019 with tepid gains. PCE inflation was also muted at 1.4% (y/y) overall and 1.8% for core.

Housing data also came in on the disappointing side. Housing starts declined 8.7% in February, giving back most of the gains in January. The turn lower was concentrated in the single family segment. Meanwhile, the pace of new home sales perked up to the best rate in almost a year (4.9%). Additionally, in January, home price growth decelerated to the slowest rate in almost 4 years – 4.3% (y/y) down from 4.6% a month earlier. It also marked 10 consecutive months of slowing growth (Chart 2). Higher mortgage rates earlier in 2018 and the past run-up in home prices dented affordability. However, recent declines in rates, smaller price gains, and rising wages should result in improved activity going forward as housing demand rebounds (see report).

On the trade front, the trade deficit narrowed sharply in January, from $59.9bn to $51.1bn, implying less of a drag on GDP growth from net trade in 19Q1. The improvement largely reflected shifting trade with China. Fortunately, there appears to be some progress in negotiations. China is offering concessions on technology-related issues, which had been a major sticking point for U.S. negotiators. Trade talks continue in Washington next week.

Across the pond, the Brexit saga continued to unfold, leaving a lingering air of uncertainty. The UK’s Parliament failed to come to a consensus on alternatives to the withdrawal agreement on Wednesday. Out of eight options proposed, not one was able to garner the needed majority. Parliament voted for a third time against the deal today, the day Britain was originally set to leave. Prime Minister May, who offered her resignation in exchange for support, continues to face an uphill battle to consolidate opinion on a deal. Debate on a deal is expected to continue next week.

Lastly, a parade of Fed speakers made the rounds this week. Among them, Chicago Fed President Evans echoed sentiments expressed in last week’s Fed statement – a rate hike for 2019 is likely not in the cards, while his Philadelphia counterpart, Patrick Harker, suggested one hike could be appropriate. All told, policy normalization at the Fed is quite likely nearly complete, as rising global risks leave the U.S. exposed to foreign shocks.

Shernette McLeod, Economist | 416-415-0413