Fears of a Trade War and US Economic Slowdown

Stocks may very well stay under pressure over the next couple of weeks -- before Q218 corporate earnings are reported -- from fears of a trade war and a related US economic slowdown/recession at some point. 

This week's US economic data are minor, but risk exacerbating slowdown fears.   Two of the bigger releases --  May New Home Sales and Durable Goods Orders -- are expected to fall modestly.  The underlying Ex Transportation Durable Orders are seen rising at a slower pace than in April.  I'd pay attention to the June Richmond Fed Mfg Index (due Tuesday), since it has correctly matched the m/m direction of the Mfg ISM Index (due July 1) so far this year.  The risk is for a decline.

To be sure, fears of a trade war and sharp economic slowdown may not pan out, opening the door for a further stock market rally.  Trump may succeed in getting the EU, Canada, Mexico and China to bend, allowing all sides to declare victory.  And, US economic growth would remain above trend if a slowdown matches the expectations for H218 Real GDP Growth in the Fed's Central Tendencies (see my June 10 blog).

There may be movement on trade behind the scenes.  A NY Post article said the US ambassador to Germany had persuaded the Germans to agree to drop a tariff on US-made cars, but had not yet gotten agreement on trucks.  NY Times and others reported a push by some White House officials to restart direct talks with China.  While the past week's headlines were mostly negative, they could change unexpectedly.

Financial Market Conditions are just mildly restrictive as a result of the 50-BP hike in the Fed Funds Rate so far this year, supporting expectations of only a modest US economic slowdown (see table below).  The jump in oil prices may be exaggerated, since about 5% pts of it happened on Friday in response to the OPEC output decision -- and could be an overshoot.

Market commentators have focused on the flattening in the yield curve (2-/10 Yr Tsy Spread down 9 BPs), as possibly pointing to slower growth ahead.  The flattening may be larger than it looks.  If an estimated 50-75 BP boost in the 10-year yield from the huge Federal Government Deficit is taken into account, the flattening would equal the estimated boost plus the actual 9 BP point narrowing in spread, 59-84 BPs.  But, another possibility is that Trump's tariffs have lifted the trade-weighted dollar, as I've argued in past blogs, which in turn has lowered inflation expectations and spurred large capital inflows from abroad into the longer end of the curve.  In this case, the flatter curve does not have such dire implications for future US economic growth. 

                                                        Financial Market Conditions
                                                          (Change So Far This Year)
10-Yr Tsy Yield            2-/10-Yr Tsy Spread         S&P500          T-W Dollar            WTI Oil Price
  49 BPs                               -9 BPs                             3.0%                   4.1%                       13.4%