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Looking for tariff effects in the latest inflation data
Simply Economics - April 13, 2018
By Mark Pender, Senior Editor



The week was heavy with inflation data the sum of which isn't raising any red flags, that is not shrinking the margin of error for the Federal Reserve. But the week does offer data on the effects, at least the very initial ones, of U.S. import tariffs on steel and aluminum. Will we look back and ask whether trouble was brewing in March's inflation numbers? Let's go through the data and see.


The economy

Let's start off with the most unusual citing of the week. Inflation expectations among businesses are up 2 tenths this month to 2.3 percent. That doesn't sound like much but it is noticeable in the blue line of the accompanying graph. And it is the highest level in the report's 7-year history. But the Atlanta Fed, which compiles the data, doesn't offer any analysis or respondent commentary to go along so the gain is a bit mysterious. Or is it? Looking at reports that do offer respondent comments, such as the ISM, concerns over tariffs and the price volatility they're causing for the factory and construction sectors is front and center. The graph also tracks year-ahead inflation expectations among consumers which definitely aren't showing any reaction to tariffs, at least for now. President Trump announced very sizable tariffs of 25 percent on steel and 10 percent on aluminum in early March which took effect a couple of weeks later but led immediately to higher prices in the wholesale market.


Producer prices, reflecting a small boost from metals prices, rose 0.3 percent in March with the ex-food and ex-energy core rate also up 0.3 percent, both of which were on the high side of expectations and among the firmest results over the last year. Wholesale prices for steel mill products jumped 1.9 percent in March with steel scrap up 4.3 percent and fabrications up 1.6 percent. But these are not outlandish gains for these readings and whether these increases are being passed through to finished products is uncertain. And aside from metals, producer prices remain tame with related service prices, considered a leading indicator for goods, not showing much pressure at all, up only 0.2 percent in March and continuing to lag overall growth.


But it's definitely service prices that are the story of the consumer price report, specifically the March comparison with service prices a year ago. It was in March last year that prices for wireless services began to plummet, upsetting the Fed's expectations at the time for forward progress in inflation. This easy comparison with March 2017 made for a 3 tenths jump in the year-on-year core rate to 2.1 percent this March. But the month-on-month gain for the core, where the comparison with last year is not in play, didn't show much punch at all, up only 0.2 percent. Still, year-on-year rates are on the climb with total consumer prices up 2 tenths to 2.4 percent. This is the first time in a year that both readings have made the 2 percent line.


Yet a look at the monthly breakdown does show a lack pressure for consumer prices, whether for services or goods. Service prices (blue line) came in at only 0.2 percent in March and are not pointing to any acceleation at all. This while goods prices (red columns), pulled down in March by gasoline, are moving in the wrong direction. Commodity prices are in fact dominated by energy prices which means metals prices are going to have to rise significantly over a long period of time to have much visible effect on consumer prices.


Not having much inflationary impact, if any, has been the decline in the dollar, down nearly 10 percent last year and down nearly 3 percentage points so far this year. The Fed is counting on dollar depreciation to give imported inflation a boost and they're still waiting. The 3.6 percent increase in the year-on-year rate for import prices (blue line) is the highest since April last year but increases underway have been marginal. The depth of the green line, which tracks the trade-weighted dollar, should be corresponding to greater acceleration for the blue line and the lack of progress raises the question whether foreign sellers are discounting prices to protect their U.S. market share.


The effect of metal tariffs, not to mention the potential risk of other tariffs as President Trump tries to bring down the trade deficit, is an unfolding story. Another unfolding story with perhaps greater risk of more immediate effects is the rise underway in initial jobless claims as tracked by the blue line of the graph. This 4-week average has been edging higher over the last month from the low 220,000 area to 230,000. The level is still very low and wouldn't be a concern were it not for the sizable falloff in March payroll growth which came at only 103,000 or roughly half the recent trend. Even if the rise in claims does not reflect a slowing in labor demand, it will at least hold down expectations for strength in the April employment report. Note there are other factors at play including continuing claims, which continue to edge down to 50-year lows, and also seasonal adjustments which are difficult to get right during an Easter shift (from April last year to March this year). Nevertheless, the Thursday morning release of the jobless claims report will be getting extra attention in the weeks ahead.


Markets: Fed unwind underway but slow

Lost in all the news and data lately has been the Federal Reserve's balance sheet. The graph tracks the two assets that the Fed is letting unwind, the dark green area of mortgage-backed securities (MBS) and the light green of Treasuries. By creating liquidity (printing money) to buy bonds, the Fed amassed these securities through the early part of the expansion and had been reinvesting principal as the assets mature to keep their holdings even as seen from about 2014 on. The Fed is still reinvesting its maturing bonds but to a lesser and lesser degree. You can just make out the effect at the far right of the graph, especially for Treasuries at $2.413 trillion at month-end March which is down $52 billion and roughly as planned since unwinding began back in October.


But the MBS unwinding has yet to really get underway. Looking week-to-week, the Fed's holdings were at $1.754 trillion in the April 11 week which is lower than October but only by $14 billion and noticeably short of the $36 billion of unwinding that was planned. And the green bumps at the top left of the graph show that holdings have actually gone up now and then. But  MBS unwinding, in contrast to Treasuries, can be uneven due to special factors in the mortgage market including unscheduled prepayments of principal as homeowners refinance their mortgages as well as timing differences in payments and settlements. For the Fed to get on schedule, greater declines are going to have to come. By year's end, the Fed intends to cuts its MBS holdings by $180 billion to $1.588 trillion with Treasuries down by $270 billion to $2.195 billion. How low the holdings eventually go after that is anyone's guess but it will ultimately be subject to the strength or weakness of the economy and the effect that the unwinding does or does not have on the markets.


What the unwinding means for the bond market is less demand, specifically one less very big buyer. Demand for Treasuries has in fact eased since the unwinding started, especially for the 2-year note which started October at 1.50 percent and has since jumped 86 basis points to 2.36 percent. Demand for the 10-year has also eased but less so with this yield rising from 2.35 percent to 2.82 percent for a 47 basis point move. How much of this move is due to less buying from the Fed is unknown but it is certainly a factor, as are expectations for a series of continuing rate hikes by the Fed and also expectations for increased Treasury issuance to meet a widening government deficit. Note that for Treasury market fundamentalists, the narrowing distance between the two curves, at 39 basis points at last count, points to a rising risk of economic slowing with ultimate inversion pointing to recession.


Markets at a Glance Year-End Week Ended Week Ended Year-To-Date Weekly
2017 6-Apr-18 13-Apr-18 Change Change
DJIA 24,719.22 23,932.76 24,360.14 -1.5% 1.8%
S&P 500 2,673.61 2,604.47 2,656.30 -0.6% 2.0%
Nasdaq Composite 6,903.39 6,915.11 7,106.65 2.9% 2.8%
Crude Oil, WTI ($/barrel) $60.15 $62.00 $67.31 11.9% 8.6%
Gold (COMEX) ($/ounce) $1,305.50 $1,336.70 $1,347.60 3.2% 0.8%
Fed Funds Target 1.25 to 1.50% 1.50 to 1.75% 1.50 to 1.75% 25 bp 25 bp
2-Year Treasury Yield 1.89% 2.27% 2.36% 47 bp 9 bp
10-Year Treasury Yield 2.41% 2.78% 2.82% 41 bp 4 bp
Dollar Index 92.29 90.1 89.76 -2.7% -0.4%


The bottom line

The unwinding of the Fed's balance sheet is the first-of-its-kind wildcard, one that really can't be a positive for the markets though its negative effects, if any, may prove limited. A wildcard for inflation is the price of metals and whether increases underway will work themselves through to final products. And perhaps the greatest unknown is whether tariffs stop at steel and aluminum or perhaps widen out to a full blown U.S. trade war.


Week of April 16 to April 20

Retail sales will be out on Monday morning and the news, at least based on unit vehicle sales, looks to begin the week with strength. Starts and permits on Tuesday are also expected to be upbeat for a housing sector that's struggling while industrial production on Wednesday is expected to be soft for a factory sector that's booming. Indications of metals-related inflation will be watched for in Monday's Empire State and Thursday's Philly Fed reports while general inflation signals will be a focus of the Fed's Beige Book on Wednesday. But the news of the week could come from Thursday's report on jobless claims and whether demand in the labor market is easing.




Retail Sales for March

Consensus Forecast: 0.4%

Consensus Range: 0.2% to 0.8%


Retail Sales Ex-Autos

Consensus Forecast: 0.2%

Consensus Range: 0.0% to 0.4%


Retail Sales Ex-Autos Ex-Gas

Consensus Forecast: 0.5%

Consensus Range: 0.3% to 0.5%


Retail Sales Control Group (Ex-Food Services, Ex-Autos, Ex-Gas, Ex-Building Materials)

Consensus Forecast: 0.5%

Consensus Range: 0.2% to 0.6%


Gasoline stations are expected to be the spoiler in what otherwise looks to be a solid retail sales report for March. A big rebound in unit vehicle sales is a very positive signal for the report with Econoday's consensus calling for a 0.4 percent headline rise with ex-auto sales less solid, at a consensus 0.2 percent. When excluding both autos and also gas where prices fell sharply in the month, forecasters see a strong 0.5 percent gain with control group sales, which also exclude gas, also at plus 0.5 percent.


Empire State Index for April

Consensus Forecast: 18.2

Consensus Range: 17.8 to 20.3


The Empire State index has been strong and easily beat Econoday's high estimate in March. Forecasters are calling for only limited give back with the April consensus at 18.2. Prices in this sample rose in March and further increases would add to inflation talk.


Business Inventories for February

Consensus Forecast,  Month-to-Month Change: 0.6%

Consensus Range: 0.3% to 0.7%


A strong 0.6 percent rise is the expectation for February business inventories, a build that may or may not match a gain for underlying sales which in the last report proved soft. The more sizable the build in this report, the greater the contribution to GDP.


Housing Market Index for April

Consensus Forecast: 70

Consensus Range: 69 to 71 


Home-builder confidence has been solid with the April consensus for the housing market index steady at 70. Yet confidence was strongest in December and January when customer traffic, which has since eased, proved heavy.




Housing Starts for March

Consensus Forecast, Annualized Rate: 1.269 million

Consensus Range: 1.245 to 1.310 million


Building Permits

Consensus Forecast: 1.311 million

Consensus Range: 1.300 to 1.355 million


Housing starts are expected to post a solid gain in March following what was a disappointing February. But one positive in that report was strength in single-family starts where low supply has been holding down sales. The consensus for housing starts is a 1.269 million annualized rate vs February's 1.236 million with a small decline seen for permits, at 1.311 vs 1.321 million in February (revised from an initial 1.298 million).


Industrial Production for March

Consensus Forecast, Month-to-Month Change: 0.4%

Consensus Range: 0.2% to 0.7%         


Manufacturing Production

Consensus Forecast,  Month-to-Month Change: 0.2%

Consensus Range: 0.0% to 0.6%


Capacity Utilization Rate

Consensus Forecast: 78.0%

Consensus Range: 77.8% to 78.3%


Industrial production has been consistently held back by weakness in the report's manufacturing component and that is the expectation for March, at a consensus 0.4 percent gain overall but only a 0.2 percent increase for manufacturing.

Capacity utilization has been on the climb which is the expectation for March at a 3 tenths gain to 78.0 percent.




Beige Book

Prepared for the May 1 & 2 FOMC Meeting


All 12 districts in the March Beige Book fell back into the "modest-to-moderate" camp where they've been for the last year. Given the low base, any improvement in the latest Beige Book could raise rate-hike expectations. Inflation in the last report was described as moderate and any upgrade here, including pressure tied to metals tariffs, would also raise those expectations.




Initial Jobless Claims for April 18 week

Consensus Forecast: 226,000

Consensus Range: 225,000 to 230,000


Initial claims are not expected to increase in the April 18 week with the consensus at 226,000 in what would be 7,000 decline. The 4-week average has been edging higher though the level remains low and consistent with strong demand for labor.


Philadelphia Fed Manufacturing Index for April

Consensus Forecast: 20.1

Consensus Range: 18.0 to 25.0


Details of recent Philly Fed reports have been among the strongest in the report's 50-year history especially for the two most fundamental readings of all: new orders and backlogs. Econoday's April consensus for the headline index is 20.1 in what would be little changed from March's 22.3.


Index of Leading Economic Indicators for March

Consensus Forecast, Month-to-Month Change: 0.2%

Consensus Range: 0.0% to 0.3%


March's call for the LEI is a modest 0.2 percent gain which would follow a long run of unusual strength. Weakness from the stock market and the factory workweek will be likely negatives in the March report.


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