HIGHLIGHTS OF THE WEEK

  •  For the second week in a row, action on Chinese import tariffs dominated the economic news, but markets remained positive overall, likely reflecting relief that oil prices have come off their recent highs.
  • Since China retaliated to the first salvo of U.S. tariffs, the U.S. is moving ahead with the process to impose a further 10% tariffs on $200 bn of Chinese goods, after a two-month consultation period. Tariffs will make the Fed’s job of reading inflation signals more difficult.
  • So far June CPI data showed inflation rising steadily, as expected. But, it is still too early to see much impact from tariffs in consumer prices.

 


Tariffs Make Fed’s Job Tougher


For the second week in a row, action on Chinese import tariffs dominated the economic news, in what was a relatively quiet week for data. Markets remained positive overall, despite the headlines, likely reflecting relief that oil prices have come off their recent highs.

President Trump had previously threatened that if China retaliated to the first tranche of U.S. tariffs, he would order further 10% tariffs on $200 bn worth of Chinese imports. China indeed retaliated, and so this week the U.S. Trade Representative (USTR) started the process of making good on this threat by publishing a list of goods which would be subject to a 10% tariff. To be clear, these tariffs are not immediate; they need to go through a two-month process before being enacted. The USTR will hold a public consultation period ending on August 30th.

So far, China has held off on announcing knee-jerk retaliatory tariffs. It remains to be seen what steps China might take. In the meantime, this creates uncertainty for businesses, and likely further volatility in the trade data, as businesses attempt to ramp up shipments ahead of the potential tariffs. In this way, and in prices for many commodities, even potential tariffs have an impact on real economic activity.

These tariffs will raise input prices for many American businesses, but the extent to which they are passed on to consumer prices will depend on the competitive environment of the industry. If businesses can’t pass on price increases to their customers (for fear of losing too much market share), they may have to cut costs by reducing staff or planned investments. Both of these actions will crimp growth in the overall economy. If tariffs are fully passed on to consumers you get higher inflation, and slower growth by a different channel. The federal government may mitigate the negative impact by funneling the tax revenues back into the economy.

In a perfect world, the Fed will look through one-time price increases caused by tariffs. However, if tariffs are placed on a wide variety of goods further up the supply chain, it makes it difficult to disentangle how much inflation is due to a hot economy, and how much is the result of tariffs. That raises the risk the Fed misinterprets the inflation signal.

This suggests the Fed is likely to be very cautious. This week’s June CPI data was too early to pick out evidence of import tariffs. Overall the data showed yr/yr inflation continued to rise as expected, reaching 2.9% (Chart 1). Core inflation was 2.3% yr/yr, having risen steadily for the past year. The upswing in annual inflation in part reflects comparisons to low readings last year. Monthly increases look steadier (Chart 2), with little acceleration in June.

Next week Chair Powell testifies before Congress on the economy. It should have been a straightforward good news story of a strong economy, with inflation rising in a non-threatening way and gradual increases in interest rates. Now, he is likely to face questions on the impacts of tariffs, which are both uncertain and hard to forecast.

Leslie Preston, Senior Economist | 416-983-7053


 This report is provided by TD Economics. It is for informational and educational purposes only as of the date of writing, and may not be appropriate for other purposes. The views and opinions expressed may change at any time based on market or other conditions and may not come to pass. This material is not intended to be relied upon as investment advice or recommendations, does not constitute a solicitation to buy or sell securities and should not be considered specific legal, investment or tax advice. The report does not provide material information about the business and affairs of TD Bank Group and the members of TD Economics are not spokespersons for TD Bank Group with respect to its business and affairs. The information contained in this report has been drawn from sources believed to be reliable, but is not guaranteed to be accurate or complete. This report contains economic analysis and views, including about future economic and financial markets performance. These are based on certain assumptions and other factors, and are subject to inherent risks and uncertainties. The actual outcome may be materially different. The Toronto-Dominion Bank and its affiliates and related entities that comprise the TD Bank Group are not liable for any errors or omissions in the information, analysis or views contained in this report, or for any loss or damage suffered.