HIGHLIGHTS OF THE WEEK
- U.S.-China trade tensions continued to dominate headlines as both countries dig in for another round of negotiations under more strained circumstances. U.S. tariffs against Mexico appear to also be in the works.
- As trade tensions flare, investors have run for cover, driving up bond prices and sending the yield curve into inversion territory.
- U.S. Q1 growth was revised marginally lower (3.1% vs. 3.2%), and Q2 is projected to be lower still (below 2%). Inflation however managed to edge marginally higher with core PCE at 1.6% year-on-year in April.
Trade Tensions Still in the Spotlight
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.
With concerns of lower growth and heightened trade tensions, investors pushed the yield on 10-yr Treasury notes to the lowest close since September 2017 this week. This caused the yield curve to invert as it dipped below the three-month note (Chart 2). While inversions tend to precede recessions, the phenomenon would need to be sustained and observed among other maturities before the indicator signals an imminent risk and materially affect decisions at the Fed. All said, the reignited trade tensions have skewed the risks to both U.S. and global growth further to the downside – a development which will no doubt receive close monitoring by central bank officials.
Shernette McLeod, Economist | 416-415-0413
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