How China trade tension fuels factory orders slump

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Durable goods orders dropped 2.1% in April, a sign that businesses are holding off on equipment purchases as trade tensions with China increase.

The Commerce Department report Friday also lowered the figure for March orders to a 1.7% rise from the 2.6% gain reported previously. Economists polled by IFR Markets expected a 2.0% decline in April.

“Business investment spending is expected to remain soft with nondefense capital goods orders excluding aircraft — a closely-watched proxy for future business investment spending — falling 0.9% in April, well below the expected reading of -0.3% and the first decline in four months,” Scott Anderson, chief economist at Bank of the West Economics, said in an analysis. “The decline in business capital goods orders suggests the U.S. trade war with China might be causing businesses to pull-back on their spending plans until there is a resolution to the ongoing dispute.”

A market selloff as a result of the failure of negotiations on a trade deal with China “could be a blessing in disguise,” said Chief Market Strategist Brett Ewing of First Franklin. “Before the disagreement, markets were getting a little too giddy and we began to fear that even an agreement would lead to a sell-the-news type event. Now there is almost no one who thinks a deal could be done anytime soon and we are back to an environment that is at least in line with reality and at best overly pessimistic.”

The economy is stronger than analysts say, Ewing wrote in an analysis, and GDP “will surprise to the upside … perhaps even eclipsing 3.0%” this year.

"The Fed is sending the right message to the markets in 2019 vs 2018 and the U.S. job market will allow consumers to feel more confident overall, translating into continued progress in consumer behavior leading to a stronger housing market and improved retail sales for the remainder of 2019,"

BNP Paribas’s global outlook disagrees with that assessment of GDP. “Recent robust growth in the U.S. is unsustainable, in our view,” wrote Luigi Speranza, chief global economist at BNP Paribas London’s branch. With fiscal stimulus’ impact diminishing and monetary policy tightening filtering through the economy, GDP should slip “towards its long-term trend, which we estimate to be close to 2%.”

Despite a strong labor market, increasing wages and consumer confidence, uncertainty about trade and other government policies muddies “the outlook for investment and net trade.”

The recent dip in inflation “is due more to temporary factors than to an underlying trend change,” and tariffs will push up inflation, as measured by the consumer price index to a 2.2% annual rate in the fourth quarter, Speranza wrote.

“That said, we consider it remarkable that inflation has remained pretty muted, considering the strength of the labor market and rising nominal wages, though it is too early to conclude that this is due to a shift in inflation expectations,” he added. “Combine this with likely downward pressure from methodological changes, and we are less concerned about higher inflation in the medium term than about the risk of a persistently low rate.”

BNP sees the Fed holding the funds rate target through next year, although it might tweak the interest rate on excess reserves and “other liquidity mechanisms.” However, if a move is made in that time frame, “we think it would be more likely to cut rates than hike them.”

At a conference on Thursday, several Fed presidents offered their thoughts, including Federal Reserve Bank of Dallas President Robert Kaplan, who said that he didn’t know which direction the Fed’s next move would be, but “for the moment” policy is in the right place.

He added that trade issues and business uncertainty increased in the past month and those issue may last a while.

Meanwhile, Federal Reserve Bank of Cleveland President Loretta Mester told Bloomberg News a rate cut “would be bad policy because we have another goal and the risk you’d be running on the other goal would be excessive.”

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