HIGHLIGHTS OF THE WEEK
- News of a trade truce between the U.S. and China buoyed equity markets at the start of the week. The ceasefire put additional tariffs on hold, and there were some modest concessions on both sides.
- On the economic front, messages were decidedly mixed this week. The ISM manufacturing and non-manufacturing indexes moved lower in June, while the payroll report showed a reacceleration in hiring with 224k jobs created last month.
- Given the balance of risks, there is still a solid case for a 25- basis point “insurance” cut when the Fed meets later this month. But, insurance is likely to mean one or two rate cuts this year and not four or five as markets are pricing.
Markets Celebrate The U.S.-China Trade Truce
News of a trade truce between the U.S. and China kicked off this holiday-shortened week. The ceasefire puts additional tariffs on hold. There were some modest concessions on both sides. The U.S. will allow American companies to continue selling equipment to Huawei (although specifics are still pending), while China will buy more American agricultural goods. The outcome was broadly in line with analyst expectations, but still positive enough to bouy equity markets, especially in sectors such as semiconductors hit by trade uncertainty. On Wednesday, the S&P 500 reached an all-time high.
On the economic front, messages in this week’s data releases were decidedly mixed. The ISM manufacturing and non-manufacturing indexes moved lower in June and are significantly below year-ago levels. Still, both remain in expansionary territory, implying slower, but not negative economic growth (Chart 1). More concerning is that the greatest weakness was in the forward-looking indicators. The new orders subcomponent narrowly avoided contraction in June, while pending orders have already slipped below the 50-point threshold.
It is not surprising that activity is slowing from its 3%-plus, stimulus-fueled pace of a year ago, but it makes reading the economic tea leaves more difficult. It is hard to know in real time if the economy is returning to a healthy trend-like pace or pushing past it into a slump. Tariffs and trade uncertainty further cloud the mix, and signs globally point to a less benign slowdown.
America’s saving grace may be that a large share of its economy is relatively shielded from global events. Still, while its service sector is less impacted by trade, it has not been spared entirely. Indeed, comments from non-manufacturing survey respondents highlighted concerns about tariffs in several industries, including construction, retail trade, health care & social assistance and professional and technical services.
The best evidence that the American economy is headed for a soft landing is the continued resilience in the labor market. That had been brought into question with the May payroll report (job growth slowed to just 72k), but doubts were assuaged with this week’s report showing a reacceleration to 224k in June. The only fly in the ointment was that there were no signs of faster wage growth. Instead average hourly wage growth remained unchanged at 3.1% for the third consecutive month.
Given the balance of risks, there is still a solid case for a 25- basis point “insurance” cut when the Fed meets later this month. But, as long as signs point to continued, albeit slower, economic growth, insurance is likely to mean one or two rate cuts and not four or five as financial markets are currently pricing. Fed speeches over the next two weeks will be key in communicating this to the public and financial market participants.
Ksenia Bushmeneva, Economist | 416-308-7392
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