HIGHLIGHTS OF THE WEEK
- Trade tensions continued to dominate economic headlines, with U.S.-Mexico taking center stage. It remains unclear if a deal can be reached by Monday. The US-China spat also resurfaced, with signs that it is spreading beyond goods trade.
- Fed Chair Powell noted that the Fed was monitoring trade developments closely, and was ready to “act as appropriate to sustain the expansion”. This appeared to soothe equity markets, which rebounded to a three-week high.
- The May jobs report disappointed expectations, with payrolls up only 75k. Looking through the recent volatility, the hiring trend has slowed but remains decent, averaging 151k in the last three months. The unemployment rate held steady at 3.6% and wage growth, while slowing a touch, held above 3% y/y.
Tariff Threats Muddy the Economic Waters
Trade tensions continued to dominate economic headlines this week, with the U.S.-Mexico quarrel taking center stage. Mexico sent a senior delegation to D.C. to try to address President Trump’s concerns regarding illegal migration, and to defuse the impending tariff threat. While some progress has been made, as at the time of writing, it is unclear if a deal can be reached by Monday’s deadline.
With Mexico busy at the negotiation table, President Trump tilted the conversation back to China by reaffirming the threat to raise tariffs on another $300 billion of Chinese goods. China’s Commerce Ministry struck a defiant tone in response, suggesting that China would “fight till the end” if need be. Beyond the colorful language, there were signs that the conflict is spreading beyond goods trade, with China cautioning its citizens about the dangers of travelling or studying in the United States.
The uncertainty generated by these events has kept the Fed on high alert. Among several Fed speeches this week, Fed Chair Powell noted that the Fed was monitoring trade developments closely, and was ready to “act as appropriate to sustain the expansion.” Chair Powell’s emphasis on the Fed’s flexibility appeared to soothe equity markets, which rebounded to a three-week high.
Financial conditions factor heavily in FOMC decisions, but economic data is the primary determinant. On that front, data this week reinforced the view that while growth has slowed, there are no impending signs of calamity. Trade tensions are weighing on the manufacturing sector, but the much larger services (non-manufacturing) side of the economy is holding up, as highlighted by the divergent performance of the ISM indices through May (Chart 1). That said, the most awaited report of the week, the jobs report, was a bit of a downer, with payrolls rising by only 75k in May – over 100k short of market consensus. This came alongside downward revisions of 75k to the previous two months. Looking through the recent volatility, the hiring trend has slowed but remains decent, averaging 151k in the last three months (Chart 2). This is broadly in line with our expectations. In addition, most other aspects of the May report were encouraging. The unemployment rate held steady at 3.6% and wage growth, while slowing a touch, held above 3% y/y.
With the broad economic backdrop still decent, trade and global growth remain the ultimate wildcard. Mexico is the second biggest source of goods entering the U.S. after China. As such, the impending 5% tariff will be problematic, particularly for products that cross the border multiple times (i.e. auto parts). Prospects for an increase in the tariff rate to 25% are more daunting, with supply chain disruptions, reduced market access and the hit to confidence all more acute. A simultaneous escalation in tensions with Mexico and China would accentuate these risks further. In the event that tensions escalate in this fashion, the Fed will have little choice but to act.
Admir Kolaj, Economist | 416-944-6318
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