An international mixed bag

September 05, 2018

Developments in international trade policy dominated the headlines last week. On the positive side, the U.S. and Mexico reached a preliminary agreement on the broad outlines of a deal. The sides made progress after months of fits and starts renegotiating NAFTA. But we highlight a couple of important points: the sides still need to iron out the finer details, Canada has not yet agreed to the terms of the deal, and Congressional approval could complicate the process, especially if Canada is excluded and control of the House changes. Markets and businesses continue to see Canada's membership in any trade agreement as important. We still believe that the three parties will reach an agreement, but see the process likely taking longer than a few months to allow enough time for a thorough review of the deal

On the negative side, the president recently deemed insufficient the proposal from the European Union to remove tariffs on all industrial imports. This potentially ends the recent détente between the U.S. and E.U. that occurred when Presidents Trump and Juncker met in Washington in July. And the president has also signaled that the U.S. could move forward with tariffs (as soon as this week) on an additional $200 billion of Chinese imports. The president also rattled his saber about withdrawing from the World Trade Organization (WTO), though many view that as more of a negotiating tactic than a direct threat. We continue to see limited impact from trade measures, as we stated in our primer on tariffs two weeks ago, but downside risk remains.

Data remains positive

Outside of international trade, the economic data remain generally positive. The second reading on second quarter real GDP showed growth revised slightly upward by 10 basis points to 4.2 percent. Meanwhile, the third quarter got off to an auspicious start, with personal income and spending growth for July healthy, roughly in line with expectations. Inflation, measured by the Personal Consumption Expenditures (PCE) index continued to drift higher as we anticipated. Headline PCE grew by 2.3 percent year-over-year while core PCE grew by 2.0 percent year-over-year in July. Core PCE, the Fed's preferred measure of inflation, now stands at the Fed's target rate. The Fed will attempt to manage monetary policy around this target rate while mooring the labor market to full employment. 

Currently, it appears that the labor market is tighter than full employment which exerts upward pressure on wages and inflation. 

Both consumer confidence and sentiment for August remained at elevated levels, but could signal the start of some divergence. Consumer confidence increased versus July, with the assessment of the present situation hitting its highest level since 2000. And expectations increased as well, reversing the declines from the prior two months. But consumer sentiment declined slightly relative to July, the lowest final reading in seven months. Rising inflation and interest rates likely dented some consumer enthusiasm.

Implications for CRE

We continue to see limited fallout from trade issues for both the economy and commercial real estate (CRE), even in the industrial sector, which falls most directly in the crosshairs of trade policy. We acknowledge that trade policy risks lie to the downside, but alone they do not pose a systematic risk. Economic growth in the middle of this year is coming in above potential, a clear positive for CRE. Growth should fade over the coming quarters, but economic growth undoubtedly supports demand for CRE, particularly when supported by an optimistic consumer. And we continue to believe that CRE's role as an imperfect inflation hedge, potentially undervalued during periods of incredibly low inflation, could take on increased importance as prices continue to increase.

What we are watching this week

The employment situation for August should show a modest increase in employment of roughly 160,000-180,000 jobs. The unemployment rate likely ticked down to 3.8 percent, which would match its lowest level since 1969.And wage growth likely held steady at 2.7 percent, year-over-year. We expect both the ISM manufacturing and non-manufacturing indexes to show August increases. The non-manufacturing index looks to rebound after a somewhat surprising contraction in July. We anticipate that exports declined while the trade deficit increased in July. Some of this stems from a reversal of the surge in exports that occurred in the second quarter as many sought to get out ahead of tariff imposition. While trade should drag on third-quarter growth, contribution from inventory growth should offset trade, like what occurred in the second quarter.

Thought of the week

The S&P 500 Index recently passed 2900 for the first time. At its cyclical intraday low in March 2009 it stood at around 666.

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