HIGHLIGHTS OF THE WEEK
- Markets reacted positively to developments that the U.S. and Mexico had reached a trade deal. Details still need to be finalized, including Canada’s position. A revised, trilateral agreement looks unlikely to be achieved today.
- Data was broadly positive this week. Second quarter GDP was revised up slightly, and after-tax corp. profits rose to the highest y/y pace since 2012. A 0.2% July rise in real spending marks a good start to third quarter consumption.
- Core PCE rose 2% y/y in July. Steady inflation, holding at or near target since March, gives the Fed scope to continue on with its gradual reduction in stimulus. The next Fed hike is expected to come in September.
Inflation is just where the Fed wants it to be
The U.S.-Mexico trade agreement was welcomed by markets this week. Coupled with positive data flow, U.S. equities made further gains midweek. The agreement included augmented rules of origin for autos, strengthened intellectual property protections, and enhanced protections for labor and the environment (for a complete list see here). Details still need to be finalized, including Canada’s position. Today’s deadline for a tri-party agreement looks unachievable. An updated NAFTA agreement would allow the U.S. to shift focus back to resolving its trade dispute with China. News reports anticipate that President Trump will impose tariffs on an additional $200 bn of Chinese imports next week, helping pare back equity gains by week’s end.
Looking past shifting trade headlines, there was plenty to digest on the data front. Aside from pending home sales, which retreated for the 7th straight month in July and underscored the fact that housing remains a sore spot, data were broadly positive. Second quarter GDP was revised up slightly to 4.2%, beating expectations for a slight downgrade. Corporate profit data, released on the same day, added to the upbeat tone. Corporate taxes fell 33% from a year earlier, boosting after-tax profits 16% in Q2 – marking the best y/y gain since 2012. Tax cuts have indeed been bearing fruit, and they have been far more beneficial to businesses than households (Chart 1).
Personal income and spending data for July also proved positive. Nominal income (+0.3% m/m) and spending (+0.4%) recorded solid gains that were in line with prior months. On an inflation-adjusted basis, spending rose 0.2% m/m, extending the streak in real gains to five months and marking a good start to the third quarter. Last quarter’s 3.8% rebound in consumption will be hard to repeat. Nevertheless, upbeat consumer confidence, which is sitting at an 18-year high, along with continued employment gains and rising incomes all point to healthy consumer spending growth in the 2½ to 3% range for the rest of the year.
On prices, it was encouraging to see the Fed’s preferred measure of inflation holding at target. Core PCE rose 2% y/y in July, and has been in the 1.9% to 2% range since March (Chart 2). Inflation is not too hot, not too cold – it’s just right. This should allow the Fed to continue its gradual reduction in stimulus. As such, an almost certain September hike will likely be followed by another one in December.
Although the U.S. economy is experiencing a goldilocks moment, the same cannot be said for many of its international counterparts. Financial troubles in Turkey and Argentina have policymakers there battling plunging currencies and surging inflation. Argentina’s central bank hiked its policy rate to 60% this week – the highest in the world. All told, although the impact of trade policy uncertainty and turmoil in some emerging markets has been limited thus far, they remain clear downside risks to the domestic, and global, economic outlook.
Admir Kolaj, Economist | 416-944-6318
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