HIGHLIGHTS OF THE WEEK
- Equity markets rebounded this week as the U.S. administration delayed its decision on auto tariffs for six months.
- Housing starts and retail sales data for April support the narrative of healthy domestic spending this quarter.
- That said, externally oriented industries appear to be getting caught in the downdraft of weak foreign demand.Formerly resilient, U.S. manufacturing activity has softened this year, in line with global developments.
Domestic Resilience, But Weakness Abroad Taking a Toll
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
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