- Trump announces Mexican tariff until migration stops
- Cracks appear in Fed’s policy wall
- U.S. core PCE deflator expected to remain at 1-1/2 year low
- U.S. consumer sentiment expected to remain at 15-year high
Trump announces Mexican tariff until migration stops — President Trump early Thursday evening announced that he will slap a 5% tariff on U.S. imports from Mexico starting on June 10 “until such time as illegal migrants coming through Mexico to our country stop.” He added that the tariff could rise to 25% by October. The beginning of tariffs starting in just two weeks seems to give Mexico little or no apparent chance to avert the tariffs. The June S&P E-mini contract was down about -0.8% early Thursday evening on the tariff news.
If the new tariff goes into effect, it will disrupt the highly-integrated US/Mexico supply chains that exist for many U.S. companies, raising costs and reducing profits. The new tariff could also imperil the NAFTA 2.0 agreement since there is little point in having a North American trade deal to govern trade terms when the agreement can be so easily repudiated with a blanket tariff. Both Canada and Mexico are in the process of getting the NAFTA 2.0 legislation approved by their respective legislatures. Now, Mexico will look weak if it doesn’t retaliate with new tariffs on U.S. goods.
Separately, the Trump administration on Thursday triggered the process whereby the White House can send the NAFTA 2.0 bill to the House in 30 days. That White House move was opposed by House Speaker Pelosi, who has said that House Democrats need more time to assess the deal. It is not clear whether Mr. Trump’s move will anger Ms. Pelosi enough to cause her to indefinitely delay passage of the NAFTA 2.0 agreement.
The markets will be very unhappy if Mr. Trump eventually goes ahead with his long-held threat to cancel the current NAFTA agreement on six months’ notice, thus putting pressure on Congress to pass the NAFTA 2.0 bill or end up with no NAFTA agreement at all and a reversion to pre-NAFTA tariff and trade terms. That would cause a big disruption to U.S. exports and supply chains that would likely cause a major drop in the U.S. stock market.
Cracks appear in Fed’s policy wall — One of the first major cracks in the Fed’s policy wall appeared yesterday when Fed Vice Chair Clarida admitted that there were circumstances under which the Fed might be willing to ease. He said, “Let me be very clear, that we’re attuned to potential risks to the outlook. If we saw a downside risk to the outlook, then that would be a favor and that could call for a more accommodative policy.”
However, Mr. Clarida did not say that the Fed sees those downside risks at present, suggesting that the Fed is not yet actively considering a rate cut. To the contrary, Mr. Clarida stressed that the U.S. economy is currently in a “very good place.”
The markets are now discounting nearly three rate cuts by the end of 2020 even though the Fed-dot forecast is still predicting an unchanged policy this year and one rate hike in 2020. The Dec 2020 federal funds futures contract on a yield basis on Thursday fell by another -2.5 bp to a new extreme of 1.615%, which represents market expectations for an overall -73.5 bp rate cut (i.e., 2.9 rate cuts of 25 bp) by the end of 2020 from the current IOER rate of 2.35%.
Meanwhile, the 10-year T-note yield on Thursday fell by -4.7 bp to 2.213%, remaining slightly above Wednesday’s 1-3/4 year low of 2.208%. The 10-year T-note yield has fallen sharply by -32 bp since the US/Chinese trade talks effectively collapsed on May 6. Since that collapse, President Trump raised the tariff to 25% from 10% on $200 billion of Chinese goods and blacklisted Huawei, China’s second-largest technology company.
U.S. core PCE deflator expected to remain at 1-1/2 year low — The consensus is for today’s April PCE deflator to edge higher to +1.6% y/y from March’s +1.5% y/y. However, the April core PCE core deflator, the Fed’s preferred inflation measure, is expected to be unchanged from March’s 1-1/2 year low of +1.6% y/y. That would leave the core PCE deflator comfortably below the Fed’s +2.0% inflation target.
Most Fed members continue to be concerned about the inability of the deflator to remain at or above the Fed’s 2.0% target, illustrating the continued deflationary forces that are plaguing the global economy. Tariffs put some one-time upward pressure on the inflation statistics by adding the cost of the border tax to domestic goods. However, tariffs are actually more on the deflationary side in total since the higher border tax is likely to slow the U.S. economy, thus reducing demand for a wide range of products and putting some downward pressure on prices.
A clear illustration of the weak inflation outlook is the sharp drop in inflation expectations that have been caused by the weaker global economic outlook and the drop in oil prices. The 10-year breakeven inflation expectations rate on Thursday closed -0.6 bp lower at 1.75%, but remained above Wednesday’s 4-3/4 month low of 1.70%. The sharp -20 bp drop in the breakeven rate seen this month has been a major bullish factor behind the sharp rally in T-note prices.
U.S. consumer sentiment expected to remain at 15-year high — Today’s final-May University of Michigan U.S. consumer sentiment index is expected to show a -0.9 decline to 101.5 from the preliminary-May level, which would indicate a +4.3 point rise in April rather than the preliminary-May increase of +5.2 points. The U.S. consumer sentiment index in early May posted a new 15-year high, taking out the previous high of 101.4 posted in March 2018. U.S. consumers have shaken off worries about politics and tariffs and consumer sentiment remains strong on the solid U.S. economy, the very strong labor market, rising home prices, and generally strong stock prices.
