Economic Insights - March 5 - 9, 2018
Tariff tail risks
Markets are concerned about the 10% aluminum and 25% steel tariffs just announced by the Trump administration. The direct impact of the tariffs themselves is not as big of a deal as any secondary effects. Although unlikely, these secondary effects could lead to severe tail-risk scenarios. The first of which is a trade war. The last full-blown trade war was started by the Smoot-Hawley Tariff Act of 1930, lengthening and deepening the Great Depression. The World Trade Organization (WTO) should prevent trade wars from happening, though Trump has been critical of this organization. WTO rules may be tested by the United States and any country that retaliates against the current tariffs. A trade war with China specifically is not out of the question. While only the fifth-largest exporter of steel to the United States and eleventh-largest aluminum exporter, China is likely the target of these tariffs. In addition, an investigation is underway against China for stealing U.S. intellectual property. So, more tariffs or investment restrictions could come about.
There is also a danger that these tariffs may throw a wrench into ongoing NAFTA negotiations. About 32% of U.S. aluminum and steel imports come from NAFTA. On Thursday, Trump stated that tariffs would not apply to Canada and Mexico for now. However, there’s still risk that the tariffs are imposed on Canada and Mexico anyway. A breakdown in NAFTA negotiations would have negative and long-lasting consequences for the United States and the rest of North America. These events would be severe enough to cause a recession and severe market correction.
A jobs report quick take
The February jobs report held an upside surprise. There wasn’t much to dislike about the report and markets reacted positively. The United States added a whopping 313,000 jobs. Upward revisions to the last two months were also very strong, putting the three-month moving average at 242,000 jobs added per month. The unemployment rate held constant at 4.1%for the fifth month in a row. Average hourly earnings accelerated 2.6% year-over-year, down from the 2.8% pace last month, but the trend is still upward. The average work week ticked up a tenth of percentage point. That increase translated into a 2.9% pace of average weekly wage growth.
The continued strength of job growth is remarkable given the age of the business cycle. Plenty of workers on the sidelines are still retuning to the labor force. That’s keeping a lid on wage growth, which is still well below prior cycle peaks. This jobs report reinforced our view that a very strong labor market will be a key support to economic growth this year. The stock market appreciated the pace of jobs added but also the muted pace of wage growth. The strength of this report was also more than enough to keep the Federal Reserve (Fed) on track to raise the fed funds rate later this month. But, despite the low unemployment rate, soft wage growth remains. So, the Fed has got to think that labor market slack remains. That’s going to keep a lid on their inflation forecasts and keep the pace of rate hikes gradual.