FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
June 4, 2019

IN THIS ISSUE:

1. 1Q GDP Was 3.1%; 2Q Looks to Be Significantly Lower

2. Trump Thinks Tariffs Are the Solution – I Think He’s Wrong

3. Tariffs Hurt Both Sides’ Economies, Corporations & Consumers

4. Last Minute Thoughts on Trump Trade Tariffs on Mexico

Overview

Today, we’ll look at last week’s second estimate of 1Q Gross Domestic Product. While the report showed the economy still growing by just over 3%, some of the internals of the report are troubling and suggest the economy will slow significantly just ahead.

Following that, I’ll give you my thoughts on President Trump’s surprise decision to put tariffs on 100% of what we buy from Mexico. In short, I think it is terrible! While I’ve been upbeat on the economy for the last few years, I now worry that Mr. Trump’s expanding trade war threatens the longest US economic expansion on record.

1Q GDP Was 3.1%; 2Q Looks to Be Significantly Lower

The Commerce Department released its second estimate of 1Q GDP last week at 3.1%, down slightly from its first estimate of 3.2% in late April. Despite the fact that the latest estimate held above 3%, the details inside the latest report don’t look so good, unfortunately. Those details, as I’ll summarize below, suggest we won’t see anything like 3% growth in the 2Q and probably in the 3Q as well.

The troubling details in the latest GDP report include trade, inventory buildup and consumer spending. Trade alone accounted for almost one-third of the 3.1% GDP print. Export giants like Boeing, Apple and others rushed to push orders out the door in the 1Q, trying to avoid President Trump’s (and Beijing’s) tariff moves that have roiled markets since the quarter ended.

The other problem is that a fourth of 1Q growth came from business inventory buildup – usually a sign of rising business confidence – but in this context, it’s more likely a sign that businesses were building inventories ahead of the accelerating trade war. Meanwhile, consumer spending – which accounts for apprx. 70% of GDP – rose by an anemic 1.3% in the 1Q, well below expectations.

These developments and others in the latest report have forecasters dialing back their estimates for the 2Q. The Blue Chip Economic Forecast aggregate now calls for only 2% growth in the 2Q. Most economists I read are now warning that with the growing trade war, growth in the second half of this year could be significantly lower than 3%.

I should also point out that there is no guarantee 2Q growth will be 2%. Recent data have some tracking forecasts plummeting as low as 1% for the 2Q. Among those, the Atlanta Federal Reserve Bank’s GDPNow tracker puts 2Q growth at only 1.3%, while the New York Fed has it at 1.4%. And how they got there is instructive.

New York’s estimate fell by almost half a point last week – felled by a weak reading on durable goods sales and orders, an indicator of investment weakness.  It was also hit by softness in big-ticket consumer items like General Motors and Ford and retailers Home Depot and Lowe’s. If the trade war continues to expand, US consumers could well pull in their horns, whether it’s due to higher prices (tariffs) or general concerns about the economy weakening (trade war).

As regular readers know, I have been very upbeat on the US economy  the last couple of years, really since Trump was elected president. I have made it clear that I disagreed with the “perma-bears” who always believe the next recession is just around the corner.

Yet with President Trump threatening to put up to 25% tariffs on everything China and Mexico sell us over the next several months, my confidence in the economy is waning fast. Maybe there will be a deal with China just ahead. Maybe the Mexican negotiators in Washington this week can get Trump to change his mind. I hope so on both, but I wouldn’t bet on it.

As noted above, US consumer spending accounts for apprx. 70% of GDP, and as I reported in my Blog last Thursday, consumer confidence remains strong. But that could change rather quickly – especially if President Trump continues to wage this expanding trade war.

Before moving on to my thoughts on the trade war, there is a very good article in Special Articles below from CNBC’s Ron Insana entitled, “There’s Much More This Market Should Be Worried About Than Just the Trade War.” He’s right! There are plenty of troubling things happening around the world that we all need to be aware of. Be sure to read it.

Trump Thinks Tariffs Are the Solution – Why I Think He’s Wrong

President Trump announced late Thursday (via Twitter) that he would impose a 5% tariff on all imported goods from Mexico beginning June 10 – a tax that would “gradually increase” to 25% by October 1. He said it will continue “until such time as illegal migrants coming through Mexico, and into our Country, STOP.”

An across-the-board tariff on all Mexican goods would exact a serious toll on American consumers and corporations and is likely to generate significant opposition among businesses. Rufus Yerxa, the president of the National Foreign Trade Council, which represents the nation’s largest exporters, called the move “a colossal blunder.” I agree!

The president’s threat escalated his immigration fight with Mexico and is a significant move against a longstanding American ally and our largest trading partner in 2018. That’s in addition to the $200 billion worth of Chinese goods he is taxing at 25%; plus, he’s still trying to get tariffs on the additional $300+ billion that China sells us annually that would also be taxed at 25%.

Mr. Trump persists in the falsehood that tariffs are paid by America’s trading partners. The truth is that Mexico would no more pay this tariff than it is paying for the construction of a border wall. No, the evidence is clear: Trump’s tariffs are taxes paid for by Americans in the form of higher prices on imported goods and services.

You may recall that the New York Fed published a study in late May showing that Trump’s 25% tariffs on $200 billion of goods we buy from China would cost the average American household an extra $831 a year. If Trump hikes tariffs to 25% on the other $300+ billion we buy from China, that extra cost could easily more than double! 

Mexico immediately dispatched a team of senior trade negotiators to Washington to try to change Mr. Trump’s mind. If those talks fail, I fully expect Mexico to retaliate with tariffs on most or all of its imports from America.

Trump’s latest decision to put tariffs on all Mexican goods came as a complete surprise. About three weeks ago, Mr. Trump ended tariffs on Mexican aluminum and steel, and Mexico ended a tariff on American farm goods. So much for that progress.

Tariffs Hurt Both Sides’ Economies, Corporations & Consumers

Taxation is always painful, and the question always is whether the benefits outweigh the pain. In this case, Trump is using tariffs to induce Mexico’s cooperation in keeping immigrants from America’s southern border. While the cost of the tariffs would be paid by Americans, the Mexican economy will almost certainly suffer a loss of sales to the United States.

Mr. Trump might succeed in pressuring Mexico to take stronger steps on immigration.  Yet most of the migrants seeking to cross our southern border are fleeing problems in Central America that are beyond the control of the Mexican government. Moreover, while Mr. Trump tends to refer to all the immigrants as “illegal,” many are exercising a legal right to seek asylum in the US.

Past administrations have sought cooperation from Mexico on immigration issues without disrupting economic relations between the two countries. Mr. Trump's decision to mix the two issues threatens to disrupt both economies because the manufacturing sectors in Mexico and the United States are tightly intertwined. According to Deutsche Bank, apprx. two-thirds of US-Mexico trade is between companies that have factories in both countries.

The auto industry is the largest and most important example. Many vehicles are produced by a combination of Mexican, Canadian and American factories. The Ford F-150 pickup truck – the best-selling vehicle in the United States – is assembled at factories in Kansas City, MO and Dearborn, MI – but 15% of the parts come from Mexico.

Similarly, vehicles assembled in Mexico are full of American parts. By one recent estimate, American parts make up 38% of the value of the average vehicle exported to the United States from Mexico. Mr. Trump’s tariff is a threat to that line of business, too.

Finally, Mr. Trump’s tariffs could also derail his efforts to secure approval of a renegotiated US-Mexico-Canada Agreement (NAFTA 2.0) – the deal that sets the terms of trade among the member countries. How does that critical agreement go forward with 25% tariffs on everything we buy from Mexico? Answer: It doesn’t!

Last Minute Thoughts on Trump Trade Tariffs on Mexico

There has been widespread criticism of the president’s planned trade tariffs against Mexico that he announced late Thursday. This week there has been a great deal of speculation that he will not go through with it. I disagree. Based on Trump’s comments in London yesterday and today, I believe he will indeed place a 5% tariff on Mexican goods on June 10.

Yet I also believe there is a very good chance Mr. Trump will not follow through with his plans to increase the tariffs to 25% by October 1. The reason is, migration to the US from Central America declines significantly as we get into the super-hot months from late June to early September. The president can use this decline to claim that his tariffs are working and Mexico is doing a good job of reducing the flow of migrants.

If I’m right, President Trump won’t have to ratchet up the tariff to 25%, which would be terrible for both countries, and he might be willing to remove the tariffs altogether sometime this summer. Maybe that’s wishful thinking on my part, but you read it here first.

Best regards,

Gary D. Halbert

SPECIAL ARTICLES

US Gross Domestic Product Revised Lower to 3.1%

There’s Much More This Market Should Be Worried About Than Just the Trade War

Mnuchin & Lighthizer Opposed Trump’s Tariffs on Mexico

Gary's Between the Lines Blog: Consumer Confidence: Big Jump in May Despite Trade War

 

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