We're In The Eye Of The Storm, As Tailwinds Become Headwinds

Scoop

3 days ago

Last week was very much a US story. To be fair, these day's that's become the norm. But between friendship fallouts, and a number of slowing US indicators, there was plenty to digest.
We've seen a front loading of activity in anticipation of tariffs. And we may now be seeing the start of the unwind. Both of which cloud what's happening to the actual trend growth beneath. There has been a shock to sentiment, and conditions are deteriorating.
Our COTW takes a look at the slowdown in US output, but rise in inflationary pressure.
Here's our take on current events
We're officially one month away from the end of the 90-day pause on reciprocal tariffs. And so far, we've had one deal. One. It's with the UK, and it's with loose ends. We would have expected many more by now. And still hope for many more to come between now and July 9th. But if the current track record is anything to go by, it's painfully slow. We remain in limbo. And President Donald Trump's attention seems to be elsewhere, with his very public breakup with Elon Musk.
Beyond the playground drama, the US economy is starting to pay the price of the tariff turmoil environment. We've been waiting and watching, trying to gauge the tariff impacts. And it feels like we're in the eye of the storm.
We know, mostly anecdotally, that there has been a lot of front-loading. Car sales for example, surged in March, only to fall off a cliff in April. And we've seen a further pullback in Chinese sourced goods over the month of May.
The front loading of activity, and growth, is common sense. We saw similar reactions when GST was introduced. If you know a tax hike (GST or tariff) is coming, you buy now, not after. The inflation gauge spikes, temporarily, and then returns to levels seen before the tax hike. So, what we saw in the first half of the year, was a confused front loading. And what we'll see over the second half, is an unwind. In fact, we're possibly already seeing that unwind now.
Monthly trade data out of the US last week showed signs that the recent front loading of imports into the US may be coming to an end. The US trade deficit over April narrowed 55.5% - the most on record- led by a record 16.3% decline in imports. And the value of US imports from China fell to its lowest level since the early months of pandemic when borders were physically shut.
Nevertheless, as economists, it's difficult to strip out the likely front loading from the actual trend growth beneath. And it's equally difficult to strip out the unwind. So, growth may be rosy for now, and bleak a little later.
So, what do you do? Well, we turn to sentiment indicators. And there has been a shock to sentiment, as you'd expect given all the uncertainty.
Last week we saw a fall across US PMI surveys indicating a contraction in activity. See our COTW for more, but essentially the surveys can be summed up simply as firms are facing weaker activity but persistent inflation pressures. That's painful.
Everything that happens in an economy washes out in the labour market. If we're growing, businesses hire. If we're stalling, businesses retrench. The US payrolls report is the 'glamour stat'. The red carpet gets rolled out on the first Friday of every month, and camera crews fight for a glimpse into the labour market. Well last month's report was released on Friday, and the labour market is bending, not breaking. Payrolls have softened but not dramatically, with 139k for month of May (with consensus 120k). The unemployment rate was unchanged at 4.2%, while the level of underemployment held steady. That's good. And wages posted a solid gain of 3.9%. Again, that's good. But we're sitting here knowing it's still way too early to see the full impacts of the tariffs. And there are some questions around the strength of the payrolls report, with the ADP (a pre-payrolls payrolls report) declining noticeably this year, to just 37k last month. Conditions have weakened… but we're in the eye of the storm. We felt some tailwinds to start, with pre-loading, and face headwinds ahead, as the full force of the tariffs come through.
This week we get the US inflation report for May. We haven't seen impact of tariffs in the data yet. But we're watching. US surveys show higher, or elevated, inflation is expected, but it is not yet in the hard data.
Chart of the Week: US firms are feeling the heat.
Cracks in the US economy are starting to form. The recent flow of high-frequency data isn't looking too good. The ISM surveys for the month of May were especially disappointing. The manufacturing PMI fell from 48.7 to 48.5, the lowest in six months. And majority of its components also signalled contraction (a reading below 50). The new export orders fell 3pts, while production contracted for the third straight month and remains well below pre-covid levels. At the same time, the prices paid sub-index expanded for the fourth straight month, and the supplier deliveries sub-index rose 2pts suggesting a hoarding of inputs ahead of tariff escalation.
The services PMI posted a deeper slide in May. Economic activity in the sector contracted for the first time since June 2024, with the index plunging 1.7pts and slipping into contractionary territory. The drop in the headline index reflected a plunge in the new orders component, down 5.9pts. And the prices paid sub-index increased to the highest level in 30months.
Across both surveys, it's clear that output is beginning to slow, while inflationary pressures are heating up.