Tariffs are really beginning to hurt trade and manufacturing

It should not be surprising to learn that Trump's tariff war with China is having a negative impact on the US economy and global trade. Tariffs inhibit trade, and most of the tariff hikes to date have been directed at manufactured goods. The latest data show just how much this impact has been, and it is not insignificant.

Chart #1

Today's release of the August ISM manufacturing survey data showed a big drop in export orders (see Chart #1). The August reading of 43.3 was the second lowest in history of this data series, worse than the late 1998 reading, which was negatively impacted by the S.E. Asian currency devaluations in early 1998 and the Russia/LTCM implosion in late 1998. Only the Great Recession generated a weaker number, and that, in turn, reflected the worst collapse in global trade since the Depression. (As an aside, the collapse of trade that occurred in late 2008 was largely a function of the inability of exporters to get letters of credit from a global banking system that was in complete disarray.)

Chart #2

The overall ISM manufacturing survey began to weaken in late 2018, and by now, a slump in activity in the manufacturing sector has put considerable downward pressure on US GDP, as Chart #2 suggests. Though it's not likely enough to tip the economy into a recession, it is nevertheless of concern. The bond market has not been blind to this, however, as suggested by the significant decline in real yields since late last year. By my estimates, 0% real yields on TIPS most likely are priced to a slowdown in GDP growth to 2% or possibly less for the foreseeable future.

Chart #3

As Chart #3 shows, the volume of world trade has been declining since its Oct. '18 peak. (The latest datapoint is for June '19; undoubtedly the index has weakened more since then.)

Chart #4

Chart #4 reflects Chinese trade statistics through July of this year. China's exports to the US have not been greatly harmed by the imposition of tariffs, most likely because the yuan has fallen almost 13% since Trump first began slapping tariffs on Chinese imports. Chinese manufacturers effectively have absorbed the brunt of the US tariff costs by accepting a lower dollar price for their goods while receiving more yuan per dollar of sales. The decline in Chinese imports from the US can be attributed not only to China's imposition of retaliatory tariffs on US goods, but also to the fact that the weakness of the yuan has boosted the yuan cost of US imports by over 14%. 

Chinese imports from the US have suffered significantly of late. According to Chinese statistics, July'19 imports were 19% below the level of a year earlier. US statistics confirm this, showing that June '19 exports to China were down 17% from a year earlier.

Chart #5 

Tariff-related trade tensions have plagued the markets for most of the past month. 10-yr Treasury yields have fallen below 1.5%, driven by risk aversion (Treasuries are classic hedges against a weakening economy and they are the ultimate safe-haven asset) and declining growth expectations. Meanwhile, the Vix index has risen as fear and uncertainty drives demand for the risk-reducing properties of options in lieu of outright positions. 

UPDATE (9/5/19): The manufacturing sector is definitely hurting these days, but the much larger service sector—which accounts for over 70% of total private sector payroll employment—is doing just fine.

Chart #6 

Service sector business activity rebounded strongly in August (Chart #6). July's plunge was most likely a reflection of worried sentiment (this is all based on surveys of people's opinions) rather than an actual deterioration in business activity.

Chart #7 

The employment index (hiring intentions) softened a bit in August, but remains at a healthy level (Chart #7).

Chart #8

The Eurozone service sector survey reveals a continuing improvement, albeit modest, from the depressed levels of late last year. (Chart #8)

Chart #9

The service sector New Orders index rebounded in August from depressed July levels. Like Chart #6, this likely reflects improving sentiment (less worried sentiment) rather than any fundamental change in new order activity.

The service sector remains healthy, and that is a nice offset to obvious weakness in the manufacturing sector. The economy as a whole is thus likely to continue growing, albeit at a less-than-impressive pace (~2%).