Trade Tensions Cause Futures To Sell Off

Recently there has been a trend where stocks open higher and then fall throughout the day because of trade tensions. The key factor in determining when the selloff occurs is when the news comes out. If it comes out the night before, the futures decline, then the market opens less weak than the futures imply, and finally stocks move up throughout the day. That’s the action which occurred Monday. The futures sold off because on Sunday night the EU stated it would put a tariff on $294 billion worth of goods it sells to America if Trump puts the 20% tariff on European autos that he threatened to enact last week. The $294 billion tariff threatened by the EU would have a $13 to $14 billion impact on U.S. GDP.

It’s ironic to see that Trump’s stated goal of getting the EU to lower its trade barriers is being met with tariffs which are trade barriers. These tariffs won’t destroy the economy, but the fears could stifle business growth. The entire situation is very uncertain. It’s tough for a business to act on a policy because it can easily be reversed if the countries come to an agreement. Businesses don’t want to get caught up in the game of chicken.

As I mentioned, the S&P 500 recovered throughout the day. The S&P 500 was up 31 basis points and the Russell 2000 was up 0.73%. I think it’s fair to say that the S&P 500 won’t hit a record high until the tariff situation is resolved. The longer it takes, the closer the end of the business cycle will be, limiting the bull market’s gains. Energy was the worst performer as oil was down 21 cents to $73.94. Tech was the best performer as it was up 0.99%.

The Shanghai index crashed to a new low on Monday as it was down 2.52%. Since its peak in late January, the index is down 22%. The further it falls, the more leverage Trump has in the trade negotiations. To be clear, the Chinese economy is seeing a secular slowdown. It’s not weakening because of the tariffs as most are still bluster. The Chinese stock market is also less important to its economy than the U.S. stock market is to its economy.

Curve Flattens Further

The Treasury market had similarly large swings. The lowest yield on the 10-year bond was at 6:20 AM when it hit 2.82%. It closed at the high for the day which was 2.87%. The 2-year yield bottomed at 2.5% and closed at 2.55%. The difference between the 2 bonds is now only 32 basis points. Like I have been saying, the curve will invert by either August or September if the difference falls by about 1 basis point per day.

The Fed can temporarily prevent an inversion if it is slightly dovish at its August 1st meeting. The August 1st meeting will have interesting timing because the Fed will have a front row seat to watch the inversion occur. I think its fair to say the difference will be less than 25 basis points by the time of the meeting. If there’s no resolution to the trade wars, the Fed can use them as an excuse to be dovish. To be clear, there is currently a 43.2% chance of 3 hikes and a 44.2% chance of 4 hikes in 2018.

Weak May Consumer Spending

In a previous article, I discussed the inflation part of the personal income and outlays report. Even though inflation is the most important stat to review at this point in the cycle, it wasn’t the most important part of this report. The big surprise was consumption spending which was only up 0.2% instead of 0.4%. Also, the April consumption spending growth was revised lower by one tenth to 0.5%. This 3 tenth shift will cost GDP growth dearly. Nowcast models and economists have been banking on a big acceleration in consumer spending growth to drive almost 4% GDP growth. Without such growth, GDP growth will be closer to 3% than 4%.

As you can see from the chart below, in the past few quarters personal income growth has been catching up to spending growth. The month over month personal income growth in this report was 0.4%. This means the savings rate increased. Lately, the savings rate has been increasing as it was 3.2% in May, which was up from 3% in April. The recent bottom was 2.4% in December 2017.

(Click on image to enlarge)

This stat is a catch 22 because you want the savings rate to not fall that much because it signals the consumer is leveraged too much. However, usually the savings rate spikes during recessions because the consumer is nervous and pulls back spending. In this situation, it’s simply about income growth catching up to spending growth which didn’t dip much even as income growth fell from 2015-2017.

GDP Estimates Dip

As I mentioned, the GDP estimates fell because of weak growth in consumer spending. The latest update from the CNBC GDP tracker has the average and median estimate at 3.8%. The Atlanta Fed GDP Nowcast took a sharp tumble from 4.5% to 3.8%. It made the tumble many bears have been predicting ever since the initial optimistic estimate was released in early May. The estimate for real personal consumption expenditures growth fell from 3.7% to 2.7%. This quarter quickly went from a big acceleration in consumption, to a more normal growth rate after the weak Q1.

Just like the Atlanta Fed Nowcast, the NY Fed Nowcast hit its lowest point of this quarter. The NY Fed Nowcast fell from 2.87% to 2.79%. This is the most bearish estimate I’ve seen. The durable goods shipments caused the indicator to fall 9 basis points and the new orders caused it to fall 4 basis points. The consumption growth disappointment caused it to fall 5 basis points. Finally, the St. Louis Fed Nowcast expects GDP growth to be 3.54%.