The Week Ahead – Houston We Have a Problem

Welcome to “The Week Ahead” where we take a moment to provide our thoughts on what we can expect in markets and the economy during the upcoming week.

A few weeks ago, one of my favorite economists had an interesting note that invoked the movie Apollo 13. In reference to the strong economic data, he quoted the iconic scene of the pre-launch systems check:

“Listen up. Give me a go/no go for launch.

Booster? Go. RETRO? Go. FIDO? We’re go, flight. Guidance? Guidance go. Surgeon? Go, flight…..INCO? Go. FAO? We are go. Network? Go. Recovery? Go. CAPCOM? We’re go flight.

Launch Control, this is Houston. We are go for launch!”

While our economy continues to be “go for launch” with strong economic growth, low unemployment and benign inflation; this latest flare-up in trade tensions with China will most likely have a meaningful impact on the global economy. The world’s economy was already decelerating and a full-fledged trade war is another body blow. The Chinese have been stimulating their economy to offset economic weakness, and President Trump is calling on the Federal Reserve to “match” them by reducing short-term interest rates. After disappointing retail sales numbers last week, the bond market is pricing in a 57% probability the Fed cuts interest rates in September and essentially one-third probability of a cut in July.

The first order effects of the tariffs on Chinese imports, which are essentially a tax on the importer, are fairly small and straightforward. It is the secondary and tertiary effects which are causing market volatility. The uncertainty caused by the stand-off between the two remaining super-powers resulted in the stock market losing more than a trillion dollars of value. If tariffs escalate, and a 25% tariff is applied to all Chinese imports, it would result in about $135 billion in trade taxes, which would essentially increase domestic taxes by 2.5%. Furthermore, it may increase inflation by approximately 0.7%. There are also broader concerns about what this trade dispute may do the Sino-U.S. relationship beyond our economic differences.

This week is very light in terms of economic indicators. With mortgage rates falling below 4%, we would expect to see a pickup in home sales. That would be an encouraging sign for the economy, markets and the continuation of this economic expansion.

Data deck for May 20-May 24: