Trade talks and weaker manufacturing, what will the Fed do?

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The U.S. and China are again attempting to work out trade differences, and manufacturing numbers show somewhat weaker expansion. Will this be enough to spur the Federal Reserve to lower interest rates later this month?

Fed officials continue to vow to “act as appropriate” to maintain the expansion, yet they have yet to explain what it would take to give the markets the rate cut they expect.

Speaking in New York last week, Federal Reserve Bank of San Francisco President Mary C. Daly said continuing uncertainty and weak economic numbers would “make me think and consider whether further accommodation is needed.”

And on Monday, Fed Vice Chairman Richard Clarida, speaking in Helsinki, repeated that although the baseline outlook is positive, because of uncertainty, central bankers see more of a case for adding accommodation, and the panel will “act as appropriate” to keep the economy moving forward.

The Beige Book noted concerns about trade and what talks would mean for business investments.

“Agreeing to talk is better than not agreeing to talk,” said Thomas Prusa, professor and chair of economics at Rutgers University, but there is “no evidence that we are any closer to a substantial agreement.”

He believes there will eventually be a deal “that essentially returns us the same place we were in 2016. China will remove its tariffs, the U.S. will remove its tariffs, and in exchange will be an agreement heavy on goals and aspirations, light on enforceable policy changes.”

Morgan Stanley Research agreed that it’s too early to celebrate. “This is an uncertain pause — no immediate escalation, but still no clear path toward a comprehensive deal.” While the U.S. won’t impose the 25% tariffs it threatened on $300 billion of imports from China, and both sides “will roll back some non-tariff barriers,” there’s no “clarity on whether real progress was achieved on the sticking points that caused talks to break down in the first place.”

Their conclusion is this won’t remove uncertainty and will weigh “on corporate confidence and the macro outlook.”

“I’ve long been confident that the U.S. commitment to open trade will ensure a common-sense resolution to the tensions with China,” said Steven Rosen, co-CEO of private equity firm Resilience Capital Partners. “I think that commitment will outweigh the very real — but ultimately transitory — political, economic and financial issues separating the two nations.”

Manufacturing expanded at a slower pace, according to the Institute for Supply Management’s June Report on Business, with the PMI index dipping to 51.7% — its lowest reading since October 2016 when the index was at the same level — from 52.1% a month earlier.

Economists polled by IFR Markets expected a bigger drop to 51.0%.

The backlog of orders index inched up to a still contractionary 47.4 in June from 47.2 in May and the suppliers deliveries index fell to 50.7, its lowest reading since September 2016, suggest softer demand and slowing momentum.

This was the third consecutive month that the PMI index slowed, which is not surprising, “given the headwinds facing the manufacturing sector, everything from tariffs and trade tensions to fluctuating currencies to flagging production in some regions,” Rosen said. But he expressed concern “that the trend in the U.S. reflects a global slowdown in manufacturing.”

The June Milwaukee Report on Manufacturing, released Friday, showed expansion, after contraction in May. Respondents reported a decline in production based on “seasonality” and supply chain issues resulting from a lack of qualified workers at suppliers.

The Federal Reserve Bank of Kansas City reported Thursday manufacturing in the region “was relatively flat,” in June, but most contacts remained confident in the economy and most have not changed employment or capital spending plans for the year. The Bank also reported Friday the region’s services sector also “slowed to roughly flat levels in June, with positive expectations for future growth.”

Midwest economy
The Federal Reserve Bank of Chicago’s Midwest Economy Index dropped to negative 0.28 in May, its lowest level since February 2010, from negative 0.02 in April. A negative reading suggests below-trend growth.

Construction spending
Construction spending declined 0.8% in May, the Commerce Department reported Monday. The April number was revised to 0.4% growth from the initially reported unchanged level. Private construction fell to its lowest level since January 2017. Economists expected a flat reading.

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Monetary policy Economic indicators Manufacturing industry Richard Clarida Mary Daly Federal Reserve Federal Reserve Bank of San Francisco FOMC