Tariffs and Employment

The stock market's rally should not be derailed by this week's key US economic data if consensus-like data print.  Trump's vow to impose tariffs on Canada, Mexico and China will hover over the stock market in coming weeks.    However, for the moment at least, the headlines may not be all bad for the market.

Consensus looks for a benign November Employment Report, showing only a moderate bounce-back in jobs from the adverse effects of October's bad weather and strikes.  Nonfarm Payrolls are seen bouncing back to +183k m/m from +12 in October.  If the adverse effects amounted to about -100k in October, a full bounce back would result in a print over 200k.   So, the consensus estimate implicitly assumes some softness in labor demand outside of these effects.  The Claims data support such assumption, as they hint of weaker hiring more than offsetting fewer layoffs.  With the consensus estimate, the two-month Payroll average is close to 100k -- below the level consistent with a steady Unemployment Rate.  Nevertheless, the Rate is expected to be steady at 4.1%.  Average Hourly Earnings (AHE) could be the most important part of the Report.  Consensus sees a slowdown to the old trend of 0.3% from 0.4% in October.  If AHE does not slow, it would provide more evidence that wage inflation has become problematic.

It's too soon to say whether Trump's announced intention to impose 25% tariffs on Canada and Mexico and 10% on China will have a significant impact on US economic activity or inflation.  The tariffs may be bargaining tools to push these countries to clamp down on drug traffic and immigration to the US.  Presumably, the tariffs will not be implemented if agreement is reached in these areas.  Any news of a start of bi-lateral negotiations between any of these countries and the US will be a market positive.  The Mexican President's promise to stop immigrants from crossing her country and reports of US/Venezuelan discussions move in that direction.        

The direct impact of the tariffs are likely to be less than the stated increases.  Dollar appreciation against these three countries, which has begun already, will offset the inflationary impact.  These countries' currencies have depreciated a lot (the mirror image of the dollar appreciation) over the past few months and will likely depreciate further (see table below).  The timing of the currencies' depreciation is not coincident with the tariffs, but could allow exporters to absorb at least some of the tariffs instead of passing them through to prices.  

There are other potential consequences of the tariffs.  Some production could shift to the US or other countries, with inflationary consequences stemming from higher costs of production and/or greater pressure on labor markets.  The latter could be offset by weaker US exports to these countries, as the stronger dollar make them less competitive with the rest of the world.  On balance, the size of the impact of the tariffs on the US economy is not clear.  Regardless of the impact on the US economy, the stronger dollar lowers the dollar value of profits earned abroad by US companies.

                               Approximate Change in Value Against the US Dollar

                               Canadian Dollar        Mexican Peso        Chinese Yuan

                               -5% since Sept          -23% since May      -4% since Sept