Trump's threat to use tariffs to achieve a non-economic foreign policy goal is not good news for the stock market. Even if Mexico capitulates to his demands, the risk is that the Administration will take its eye off the economy for some other goal in the future.
To be sure, with the Mexican President protesting innocence about allowing immigrants to travel unimpeded through Mexico and sending his Foreign Minister to Washington on Wednesday to explain the Mexican position, the market might just experience sharp volatility rather than head directly south.
A tariff on Mexican goods would be a drag on the US economy. Although a 5% tariff on the roughly $350 Bn in Mexican imports equates to only a $17 Bn tax hike, Trump threatened to raise it by 5% pts each month until it reaches 25% (bringing the tax to about $90 Bn).
Maybe more significantly, the tariff threat lowers the importance of the economy in the spectrum of policy targets -- never a good situation for stocks. The economy is now subordinate to immigration for the Administration. This means that while some of this week's key data for May risk strengthening, doing so will likely prompt only a muted boost to the market. The more important factor will be whether Mexico caves in to Trump's demand to stem the movement of immigrants toward the US (market positive) or retaliates in some way (market negative).
Meanwhile, developments in Asia do not look promising. A near-term agreement between China and the US does not look likely, as China is retaliating with an "unreliable entities" list. Moreover, North Korean President Kim Jong Un is reported to have executed 5 officials tied to the unsuccessful summits with Trump, including the special envoy to the US. This sounds like he closed the door on future negotiations, probably with China's consent.
Perhaps, Trump's heavy-handed approach to negotiating is backfiring. It may be facing the same failure as did the heavy bombing of London and Berlin in WWII. Rather than pressuring an adversary into submission, the bombing strengthened its resolve to fight harder. Note, however, that the bombing of Hanoi in the Vietnam War apparently succeeded in pushing the North Vietnamese to conclude peace talks. So, history is not one-sided on the issue.
The two key US economic data this week are the May Mfg ISM and Employment Report.
The May Mfg ISM risks rising, possibly by more than the consensus estimate of a slight increase to 53.0 from 52.8 in April. The two most reliable predictors -- Phil Fed Mfg Index (correctly predicting direction in 4 of 4 months this year) and Richmond Fed Mfg Index (correct 3 of 4 months) -- both rose in May. The Mfg ISM would have to rise above the 54.6 Q119 average to be viewed as strong.
May Nonfarm Payrolls should slow from the very strong +263k m/m April increase, based on Claims data. But, a gain over 200k cannot be ruled out, which would be well above the +180k consensus estimate. Payrolls averaged 186k m/m in Q119 and 223k over 2018. Perhaps more important will be whether the Nonfarm Workweek rebounds to 34.5 Hours (consensus estimate), after dipping to 34.4 Hours in April. A rebound would lift Total Hours Worked, making them more consistent with 2+% Q219 Real GDP Growth. In April, THW were only 0.5% (annualized) above the Q119 average. More generally, a rebound in the Workweek would suggest the April slowdown seen in many US economic data resulted from temporary problems, such as weather.
The idea of non-inflationary wage inflation will probably not be dispelled by May Average Hourly Earnings. Calendar considerations suggest a 0.1-0.2% m/m increase. The y/y would fall to 3.0-3.1% from 3.2% in April. In contrast, consensus looks for +0.3% m/m and a steady 3.2% y/y.
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