Let’s separate the three different issues that the Administration is focused on addressing when it comes to their current strategy on trade taxes. Firstly, protecting the technology of American companies from Chinese theft, a very worthy goal and this article Friday in the NY Times highlights the challenges being faced, //www.nytimes.com/2018/06/22/technology/china-micron-chips-theft.html. The second is trying to knock down the tariff induced trade barriers that other countries have relative to the US. We all want that. The last one, sort of a byproduct of number two, is trying to lower the US trade deficit. This one I believe is much more misplaced as an end to itself as trade is not a zero sum game and a deficit should not always be viewed as a negative and a surplus is not always a positive.

As for the first concern, we don’t seem to have made any progress addressing with the current tariff plan but are at least calling China out deservingly so. The 2nd one might be gaining some traction in bits and pieces and hopefully continues. The 3rd is only a symptom of everything else. Either way and regardless of how one thinks this should all be handled, the means to the intended end is immediately having negative real world impacts. 

Over the weekend the French PM met with President Xi and Xi expressed his interest in buying more Airbus planes. Harley Davidson filed an 8k this morning responding to the EU tariffs on their motorcycles. They said they expect “these tariffs will result in an incremental cost of approximately $2,200 per average motorcycle exported from the US to the EU. Harley-Davidson believes the tremendous cost increase, if passed onto its dealers and retail customers, would have an immediate and lasting detrimental impact to its business in the region, reducing customer access to Harley-Davidson products and negatively impacting the sustainability of its dealers’ business…On a full year basis, the company estimates the aggregate annual impact due to the EU tariffs to be approximately $90 to $100mm.” The US is about to lose jobs from this because HOG “will be implementing a plan to shift production of motorcycles for EU destinations from the US to its international facilities to avoid the tariff burden.” The American farmer is not too happy either right now with the price of soybeans at a 27 month low and China their biggest customer.

So in response to the trade spats we’ll have some US companies shift production overseas and foreign companies move production to the US with one offsetting the other.

Q2 earnings season will now be flooded with commentary on the impact of what has been done and threatened. The growth worries has the US 2s/10s spread now down to 34 bps, a fresh 11 yr low. Because inflation pressures are only growing and the trade stuff will only exaggerate that, the Fed’s job doesn’t get any easier.

To address its own growth issues, the PBOC cut its reserve requirements for many banks to 15.5% from 16%. The South China Morning Post said “The move is a ‘targeted operation’ aimed at supporting the weak links in the economy and not a change to the country’s ‘neutral and prudent’ monetary policy stance, the PBOC said.” The news initially helped the Chinese stock market but the news last night that the US Treasury Department was working on limiting Chinese investments in US technology companies send the Shanghai comp down 1% and lower by 13.5% ytd. The H share index was down by 1.2% and weaker by 4.3% ytd.

With 40% of its economy dependent on exports, the German IFO business confidence index for June fell .5 pt to 101.8 but that was as expected. The expectations component was unchanged m/o/m but the current assessment fell by 1 pt. The headline number matches the lowest since March 2017. The IFO said “The tailwind enjoyed by the German economy is calming down.” We’ve certainly seen that for the past few months in the data. The DAX is down 1.4% and by 4% year to date.

The US Markit manufacturing and services composite index fell to 56 from 56.6. The manufacturing component moderated to 54.6, a 7 month low from 56.4 while services were little changed at 56.5 vs 56.8.

Manufacturing was weighed down by “intense pressure on manufacturing supply chains, with delivery times for inputs lengthening to the greatest extent since the index began in May 2007.” This is something we are all now fully aware of and as I said yesterday, if it takes a week to ship a pallet of goods instead of two days, growth gets clogged up. Markit said “Manufacturers noted that a shortage of transport capacity following tighter trucking regulations had led to supply bottlenecks.” New orders were the lowest since September 2017 “partly reflecting a slight drop in export sales.” With inflation, “strong demand for raw materials and stretched supply chain capacity continued to push up average input prices in June. Survey respondents widely commented on rising steel costs and increased prices for related items.” Prices charged were little changed from April’s near 7 yr high.

The service side held up much better and “supported by another marked rise in new work and a solid rate of job creation in June.” Inflation though came along with this. “Input costs increased at the fastest rate since September 2013. Service providers widely commented on higher prices for fuel, staff salaries and steel related items. Greater operating expenses contributed to the steepest rise in average prices charged by service sector firms for almost four years in June.”

As for the outlook, “business expectations about the year ahead have dropped to a 5 month low, led by the weakest degree of optimism for nearly 1 ½ years in manufacturing. Exports are back in decline, showing the worst performance for over two years.” The recent stats on overseas growth has cleared showed a slowing. While the service side as stated was strong, “Inflows of new business into the service sector have meanwhile cooled to the weakest since January” and payroll growth was the lowest for a year.

Bottom line, while economic growth is still running above the trend of the last few years helped by tax cuts and a welcome relief on regulations, we are seeing now anecdotal evidence that transportation issues, rising raw material and labor costs and worries about tariffs is having an impact on both psychology and economic activity.

In the eternal BoJ quest for higher inflation, Japan reported May CPI up .7% ex food as expected and unchanged with April. Taking out both food and energy saw CPI up .3% as forecasted but down one tenth from April. Will Kuroda at some point acknowledge that the amount of money printed (BoJ balance sheet is now almost the same size as the Japanese economy) doesn’t correlate with one’s consumer price inflation rate?

BOJ BALANCE SHEET as % of GDP

Also, Japan’s manufacturing PMI for June rose a touch to 53.1 from 52.8 in May and vs 53.8 in April. Notably though, export orders went negative for the first time since August 2016. Markit said “With geopolitical risk aplenty, haven demand for the yen remains a downside risk to the country’s manufacturing exporters.” And, are we seeing the early signs of what global tariffs can do to global trade? Maybe, maybe not. Let’s wait to see more data.

In Europe, the June manufacturing PMI fell to 55 from 55.5 and that is the lowest print since December 2016. “Factory order inflows rose at the weakest pace in 22 months, while export growth remained close to the lowest for over one and half years” said Markit. Markit also said “Manufacturing is looking especially prone to a further slowdown in coming months, with companies citing trade worries and political uncertainty as their biggest concerns. Sentiment about the year ahead in the factory sector has sunk to its lowest since 2015.”

Fortunately for Europe, the moderation in manufacturing was more than offset by an improvement in services. The services PMI was up by 1.2 pts m/o/m to 55. The estimate was for an unchanged read. The high in this cycle was back in January when it was 58. The bright spot within services was the 10 year high in employment.

Inflation continues up in Europe. Markit said “Price pressures are also on the rise again, running close to 7 year highs. Increased oil and raw material prices are driving up costs, but wages are also lifting higher, in part reflecting tight labor markets in some parts of the regions.”

The euro is bouncing as the combined composite rate did exceed expectations.

For now, we are closing the chapter on the multi year bailout of Greece. Creditors have agreed to give them their final tranche owed and will further term out debt repayments by a decade. The Greek 10 yr bond yield is falling by 16 bps to 4.2% in response and the Athens stock market is up 1.4%. I remain hopeful that Kyriakos Misotakis will be the next leader of Greece next year and that would be transformational for their economy and markets.

Initial jobless claims totaled 218k, 2k less than expected and down from a revised 221k last week (1^st print was 218k) so we’ll call it a push relative to expectations. These remain very low levels of firing’s for reasons we all know so I won’t bother repeating the bottom line which has been the same for a while. The 4 week average of 221k is down 4k w/o/w and is near 48 year lows. Continuing claims, delayed by a week, rose 22k off the lowest since 1973.

The Philly manufacturing index for June weakened to 19.9 from 34.4 and that was 9 pts less than expected. It is also the lowest level since November 2016. New orders fell a sharp 22.7 pts but after spiking by 22.2 pts last month. Backlogs went negative, to -2.7 from +15.3 and that is the lowest since September 2016. Inventories rose two points m/o/m. Employment held at a strong level of 30.4 but the average workweek fell 10 pts. There was a 9 pt drop in delivery times (easing of supply constraints) and that led to a modest decline in prices paid and received. But, 6 month expectations for prices received spiked by 20 pts to the highest in 30 years as higher prices are coming our way. Capital spending plans did improve by 14 pts to 36.5 but only puts it slightly back above the 6 month average as it fell by 14 pts over the prior two months.

Also of note, the 6 month business outlook did weaken by 4 pts to the lowest level since also November 2016 and we have to assume that trade taxes are a concern.

Bottom line, manufacturing activity is still good but definitely moderated in this region in June and notably “the indexes for prices paid and received continued to reflect widespread price pressures. Looking ahead six months, the firms remain optimistic overall, but the survey’s future indicators continued to moderate.” I want to make a point about the supply issues I’ve talked about and we all see with respect to transportation, labor and now worries about procuring supply related to items subject to tariffs. This all inevitably impacts growth. If it takes my business one week to ship a pallet of goods instead of two days, things slow. If it takes me 3 months to find workers to add another machine, it slows growth. If it costs me more to get aluminum and steel and I need to trim costs somewhere else to offset it, it could slow growth. We will see a solid Q2 GDP performance that likely spills into Q3 but we have to understand that an economy that is running ‘hot’ relative to the supply of what business needs, it creates challenges in supporting that pace of activity.

The German auto maker Daimler news last night where they cut earnings estimates due to the Chinese trade taxes is a sign that those impacted are not always who you think as supply chains crisscross everywhere. The taxes on Daimler is on the cars they make in the US (Alabama) that is then shipped to China. They said “Fewer than expected SUV sales and higher than expected costs, not completely passed on to the customers, must be assumed because of increased import tariffs for US vehicles into the Chinese market.” A European company of course was not the target of a Chinese tariff. The same can be said of the US tariff on Chinese semiconductors where US companies will end up paying the tax.

Notwithstanding all the tariff noise, French business confidence in June held at 106 in May as expected as did the manufacturing component. Macron has really changed the entire attitude of the French economy for the better. The CAC is the best performing stock market of the major European countries. MFGA.

The Swiss National Bank remained dovish with its deposit rate at -.75% and showed no indication that it would start to raise rates. They remained obsessed with the strength in the Swiss Franc. “In light of political uncertainty in Italy, we have since seen counter movement, particularly against the euro. The situation on the FX market thus remains fragile, and the negative interest rate and our willingness to intervene in the FX market as necessary therefore remain essential.” Because of this attitude, the SNB is trapped in not being able to raise rates until after the ECB does.

I’ve said this before but will again, whenever the downturn occurs in Europe in coming years, the region’s central banks having not normalized anything will have no effective resources to deal with it.

The Bank of England again dragged their feet on raising rates as they kept policy unchanged BUT importantly the Chief Economist of the BoE voted to raise rates. The vote was thus 6-3. On the reality that they are finally getting closer to a rate hike, the pound immediately reversed itself and is now up on the day. UK gilts are also selling off with the 2 yr yield jumping by 6 bps to .77%. Their next meeting in August and odds are 70% they hike.

INTRADAY MOVE in the POUND after 6-3 vote

The one day calm in China after the comments from the PBOC were short lived as the Shanghai comp sold off by 1.4% to the weakest level in two years. The H share index was lower by 1.2% and the Hang Seng was down by 1.4%. The yuan is also lower along with everyone else against the US dollar today.

The Philippines is another emerging market central bank that has had to raise raise rates to defend their currency and they did so again overnight by 25 bps. It’s the 2nd hike in three months.