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  • U.S. stock market stabilizes but markets still view solid chance of full China tariffs
  • U.S. retail sales expected to remain strong
  • U.S. manufacturing production expected to flat-line for second month
  • Housing confidence expected to improve further on sharp mortgage rate drop

 

U.S. stock market stabilizes but markets still view solid chance of full China tariffs -- The S&P 500 index on Tuesday stabilized and closed +0.80% higher after Monday's -2.41% drop, which added to last week's decline of -2.18%.  The S&P 500 index on Monday's 6-week low corrected lower by -5.2% from the early-May record high.

The U.S. stock market has so far taken the breakdown of the US/Chinese trade deal surprisingly well with a downside correction of only -5.2%, although there is plenty of room for further stock market declines if the US/Chinese trade picture turns even worse.  The markets still seem to be taking a fairly optimistic view of the trade situation with the idea that U.S. and China, as the two most important economies in the world, have no choice but to eventually come to an agreement.

However, the U.S. and China have both painted themselves into their respective corners.  President Trump has imposed serious damage on U.S. farmers and other industries and must produce some dramatic concessions from China in order to justify his year-long trade war.  Mr. Trump is also under heavy pressure to produce a trade agreement that is dramatic enough to avoid criticism from people such as former advisor Steve Bannon and like-minded anti-China trade hawks.

Meanwhile, China has painted itself into a corner by making public its red lines that include (1) no post-agreement tariffs, (2) realistic purchase requirements of U.S. products, and (3) a balanced agreement with "dignity," which seems to be mean that China will not have to pass legislation to implement the trade deal.  China cannot back down on any of those points now without looking weak, which is something that President Xi cannot afford to do if he wants to remain president for life.

A survey taken on Monday of 40 economists by Bloomberg found that just over half of those economists believe that President Trump will go ahead with his threat to raise tariffs on another $300 billion of China goods.  At that point, the U.S. will have a 25% border tax on $550 billion of U.S. imports from China, with that tax totaling about $138 billion per year payable by U.S. consumers and businesses directly to the U.S Treasury.  However, two-thirds of the surveyed economists also believe that a trade deal will get signed before the end of this year.

As for the effect on Fed policy, the Bloomberg survey showed that 45% of the economists believe that the higher tariffs will make the Fed more likely to cut rates, while 25% say the tariffs will cause the Fed to lean towards unchanged rates and 25% say the tariffs will have no impact on Fed policy.  The survey shows that economists generally believe that the tariffs are neutral to dovish for Fed policy despite the fact that the tariffs will boost the inflation rate.  In addition, 80% of the economists said that the tariffs increase the risk of a recession by the end of 2020.

The market has boosted its expectation for Fed rate cuts by the end of 2020 by about three-quarters of a rate cut since the US/Chinese trade talks fell apart.  The market is now expecting a total of -52.5 bp of Fed rate cuts through the end of 2020 (i.e., 2.1 rate cuts), which is 19 bp more than -33.5 bp of cuts that were expected on the Friday before the US/Chinese trade deal essentially collapsed on Sunday, May 5.

 

U.S. retail sales expected to remain strong -- The consensus is for today's U.S. retail sales report to show a second strong month of gains as consumers finally came out of the hibernation they were in from August 2018 through February 2019.  Retail sales in March finally perked up with a very strong report of +1.6% m/m and +1.2% ex-autos.  The market is expecting another solid report today for April with an increase of +0.2% m/m and +0.7% ex-autos.

Q1 GDP was looking like a lost cause until consumer spending soared in March.  The question now is whether consumer spending will remain strong in Q2, thus boosting Q2 GDP even in the face of an expected inventory contraction.  Q1 GDP rose by +3.2%, which appeared to be a strong figure except that the strong contributions of 0.65 points from inventories and +1.03 from net exports will not last.  Q1 personal spending was anemic at +1.2%.  The consensus is for GDP to stabilize around +2.0% over the next few quarters, although that depends on whether support improves from consumer and business spending.

U.S. manufacturing production expected to flat-line for second month -- The consensus is for today's Apr manufacturing production report to be unchanged m/m for the second straight month.  The overall Aug industrial production report is also expected to be unchanged m/m after March's small decline of -0.1%.

U.S. manufacturing production was negative or unchanged during Jan-Mar and showed a net -0.8% decline in Q1, which illustrates how the U.S. manufacturing sector is struggling due to weak overseas growth, retaliatory tariffs, and weak business investment.  The ISM manufacturing index in April fell sharply by -2.5 points to a 2-1/2 year low of 52.8, illustrating how manufacturing confidence is slipping.  

 

Housing confidence expected to improve further on sharp mortgage rate drop -- The consensus is for today's May NAHB housing market index to show a +1 point increase to 64, adding to April's +1 point increase to 63.  The housing index in April improved to a 6-month high, rising by 5 points from December's 4-year low of 67.  The improvement in builder confidence has come mainly from this year's drop in mortgage rates.  The 30-year mortgage rate has dropped sharply by 84 bp to the current level of 4.10% from the 8-year high of 4.94% posted last November.

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