Escalation of the Trade War has Raised Downside Risks

By | August 12, 2019

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Asian shares inched up on Friday, helped by Wall Street’s rally, but fresh concerns about Sino-U.S. trade ties capped gains across the region. Weighing on risk appetite was a report from Blomberg that Washington is delaying a decision about licenses for U.S. firms to restart trade with Huawei Technologies. MSCI’s broadest index of Asian Pacific shares outside of Japan was 0.2% higher on Friday, but down 2.3% for the week. Early gains in Chinese stocks were erased after data showed the country’s producer prices fell for the first time in three years. Worries about trade wars and currency policies will keep market volatility elevated.  Rate cuts by various central banks this week underscored that the U.S.-China confrontations are just not problems for two nations, but for the entire world. A month ago, global prospects were starting to look better, but now downside risks are deepening and are raising the chances of a recession.

U.S. stocks fell on Friday following renewed jitters over the U.S.-China trade war, capping a week of big swings and high volume. President Trump said that the United States and China were pursuing trade talks, but he was not ready to make a deal, raising fears over the impact of the trade war on the global economy. Trump also said the United States would continue to refrain from doing business with the Chinese telecom equipment giant Huawei Technologies. The Dow Jones fell 90.75 points, or 0.34% on Friday to 26,287.44, while the S&P 500 lost 19.44 points, or 0.66% to 2,918.65. Investors are worried about consumer stocks ahead of the next round of tariffs. Investors are also worried that the proposed 10% new tariffs could rise to 25%. Morgan Stanley has estimated that 25% tariffs would lead to a global recession.

The economic calendar was quiet last week but financial markets were turbulent. Markets opened on Monday to news that China’s onshore USC/CNY exchange rate traded beyond the symbolic 7.00 for the first time in more than 10 years. This occurred in the wake of President Trump’s tweet threatening an additional tariff of 10% on the remaining $300 billion of Chinese imports. Markets plunged, with the S&P down 87 points and the 10-year Treasury fell to the lowest rate in three years but made up most of the lost ground by week’s end. The tariffs are likely to go into effect and unlike previous tariffs, which were aimed up the ladder of production, this one will hit consumers. Unlike manufacturers, who have some room in adjusting input costs, retail margins are thin and will likely hit the consumer with significantly higher prices. While the direct hit to consumer inflation is small, just 0.1 of a percentage point, it does have the potential to hit confidence and spending habits. For the FMOC that has stated a concern over global headwinds on the outlook, the escalation of the trade war could tip the scales to further rate cuts. Fed speak this week referenced that a more uncertain trade outlook could warrant lower interest rates. Markets have priced in a move in September, with an almost 100% rate of probability.

The escalation of the trade war has raised downside risks. Economic growth has slowed sharply over the past year from over 3% to near the current 2% annualized rate. Employment growth, while decent, has also slowed to a monthly increase of 150,000. The unemployment rate hasn’t moved since last fall. Manufacturing is struggling. If growth slows sharply below 2%, many manufacturers and retailers may decide to layoff workers in the uncertain environment caused by trade policy and slowing global demand. So far, the consumer has been largely untouched by the trade war, but a sharp increase in prices may affect confidence and spending. Businesses are already uneasy. If the unemployment rate rises and consumer become nervous, the stage may be set for a recession. The Fed will do what it can to avoid a downturn, but rates are already low. Getting easier credit won’t help if final demand is falling. A lot depends on confidence and that commodity is being shaken.

Next week will be busy in the economic calendar. We get a look at small business confidence, the CPI, retail sales, import and export prices, business inventories, industrial production and housing starts. None of the data will reflect consumer and business reactions to the proposed tariffs. However, financial market turbulence will continue. The last week saw several Asian countries cut rates in anticipation of the Federal Reserve moving, as well as greater downside risks emanating out of a weaker China. The UK had a negative second quarter as the economy is slowing ahead of Brexit. The Eurozone manufacturing weakness is starting to affect the service sector. Investment decisions are based on confidence and that window is shrinking as the dark clouds gather.

Latest Data

The U.S. Economy:

The ISM non-manufacturing index slipped slightly from 55.1 in June to 53.7 in July. The index did remain at a decent level. Details were mixed. The business activity index slipped 5.1 percentage points to 53.1. New orders fell 1.7 percentage points to 53.1. The employment index was a bright spot, rising 1.2 percentage points to 56.2. Supplier deliveries were unchanged at 51.5. The index is now in its 114th month of expansion, but downside risks are increasing. The index has been declining since its cycle peak in late-2018 and is at the lowest point since 2016. The biggest threat is the escalating trade war. The index has declined in the wake of big tariff announcements. The next round of tariffs will hit consumer goods and will likely lead to a negative reaction.

The inventory build hit the pause button. Wholesale inventories were unchanged in June, following a 0.4 increase n May. Durable goods inventories rose 0.3% in June, but nondurable stocks fell 0.4%. In all, wholesale stocks were up 7.6% on a year ago basis. In the durable goods category, computer equipment stocks rose 1.7%, followed by furniture at 1.5%. For nondurables, the decline was broad based. Drugs had losses of 2.1% and chemicals retrenched 1.2%. Wholesale sales disappointed with a 0.3% decline, following May’s 0.6% fall. The inventory-to-sales ratio held flat at 1.36, well above the year-ago ratio of 1.26.

The producer price index increased 0.2% in July, following a 0.1% advance in June and May. Final demand goods prices rose 0.4%, offsetting the 0.4% decline in June. The service PPI fell 0.1% in July. More than 90% of the rise in the goods PPI came from energy, which rose 2.3%. The core goods index was up only 0.1% in July after being unchanged in June. On a year-ago basis, the headline PPI number was up 1.7% and the core goods index was up 1.2%. This suggests that inflation remains muted and provides room for a Fed cut in September. The next round of tariffs will hit consumer items, but that will show up in the CPI, not the PPI.


Euro-zone business growth hit a wall in July, as demand slowed, according to a survey that showed a deepening downturn n manufacturing that is increasingly reflecting the services industry. The Markit Composite PMI dropped to 51.5 in July from June’s 52.3 reading. The index for manufacturing remains in decline and is starting to impact the service sector. The non-manufacturing PMI fell from 53.6 in June to 53.2 in July. Italy was alone among the bloc’s four biggest economies where the PMI rose, offering some hope of a timid recovery. Activity in Germany hit its weakest level in more than six years, suggesting Europe’s largest economy is starting the third quarter on a weak footing.

Global trade is likely to pick up only gradually in coming quarters and will reman weaker than overall economic growth, according to the European Central Bank. Weak foreign demand is the biggest drag on global growth over the past year as the tariff war between the United States and China has sapped confidence and held back investment, particularly in manufacturing. “Despite some signs of recovery, global trade is likely to remain more subdued than activity in coming quarters, the ECB said. “Downside risks for the outlook of trade have partially materialized in recent months due to the implementation of higher tariffs and the threat of a further escalation in trade tensions persists.” Overall economic activity may not be as weak, however, the ECB noted, arguing that manufacturing is especially trade-intensive so any slowdown in industrial demand will have an outsized impact on foreign trade. “Imports of manufacturing goods account for more than 50% of total gross global imports, but only make up 20% of world value added,” the ECB argued. “Hence, a sharp slowdown in manufacturing output leads to a pronounced decline in global trade than in global GDP. The ECB argued that weak trade, is mostly due to a drop in business investment, with uncertainty around the trade war exacerbated by changing car consumption habits and the end of a Chinese tax rebate for car purchases.

Important Data Releases This Week

July NFIB small business optimism index will be released on Tuesday, August 13 at 6:00 AM EDT. The small business optimism index posted back-to-back gains in April and May but like many business surveys slipped the tariff headlines of Junes. We project to index will fall from the 103.3 reading in June to 103.

July consumer prices will be released on Tuesday, August 13 at 8:30 AM EDT. Consumer prices were subdued in June, rising just 0.1%. The CPI and core indexes are projected to rise 0.2% in July. This brings the headline index up 1.7% for the year and the core up 2.1%.

July import and export prices will be released on Wednesday, August 14 at 8:30 AM EDT. Import and export prices were deeply negative in June and modest continued monthly declines are expected, with both import and export prices falling 0.1% for the month. The year-on-year contraction is expected to deepen for a 2.0% decline for import prices and a 1.2% drop in export prices.

July retail sales will be released on Thursday, August 15 at 8:30 AM EDT. Following a surprisingly strong retail sales report in June, up 0.4%, we expect a slight slowing in July to advance 0.3%. Excluding autos and gas, sales are projected to advance 0.5% in July.

July industrial production will be released on Thursday, August 15 at 9:15 AM EDT. Manufacturing was stronger in June boosted by hi-tech and business equipment and the index roe 0.4%. Total IP was unchanged for the month. July will see total IP rise 0.1% and the manufacturing will fall a modest 0.1%.

June business inventories will be released on Thursday, August 15 at 10:00 M EDT. Inventories are expected to rise 0.1% in June, following the 0.3% rise in May.

July housing starts will be released on Friday, August 16 at 8:30 AM EDT. After a disappointing June, which included a sharp decline in permits, the housing report is expected to be mixed. Starts will rise from 1.253 million to 1.260 and permits will rise from 1.220 million to 1.270 million.

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About Steve Graham

Steve is one of the premier analysts in the transportation equipment industry. On a monthly basis Steve tracks and analyzes in detail the trailer and heavy-duty truck industry. Aside from following these two sectors he is also instrumental in helping our customers analyze the economy and its impact on transportation and transportation equipment.