Trade Tensions not Impacting Factory Production, but Trade Deficit Going the Wrong Way

The Institute for Supply Management issued its manufacturing index report for August earlier this week and the results were much better than analysts were expecting.

Analysts were expecting the index to drop to 57.5 from its 58.1 reading in July. The actual number came in at 61.3 and that is the highest reading for the index since May 2004. It is also worth mentioning that it comes at what is generally considered a seasonally slow period.

The report showed that three key aspects of the index were all higher from the month before—new orders, output, and employment. The one area where there was a reason to be cautious was in new export orders for primary metals, transportation equipment, and machinery. This area saw a decline and it undoubtedly is a result of the trade tensions.

Of course there were analysts that saw the report as a sign that the U.S. economy is firing on all cylinders and is set up to continue its strong growth into the second half of the year. There were also economists that took the report as a cautious sign.

In a story from the Wall Street Journal, Steven Stanley, chief economist at Amherst Pierpont Securities, pointed out the last time we saw growth in factory production like this was in the late 80’s.

During that time, the Fed had to raise rates to almost 10% in order to push inflation down. Stanley stated, “If you want to conclude from this quick history lesson that the Fed is currently too easy and in the process of making a policy mistake, I would not object.”

The ISM report came out on Tuesday and the Trade Balance numbers for July were released on Wednesday. The trade numbers supported the idea that the trade tensions and President Trump’s policies are not helping to balance the trade deficit.

The trade deficit grew to $50.1 billion in July from $45.7 billion in June. This is the largest monthly increase since 2015. It is also worth noting that the deficit for goods and services are up by $22 billion so far in 2018. That is an increase of 7% over 2017.

A recent Bloomberg article stated that the impacts of the trade tensions aren’t limited to the United States. Manufacturing surveys around the world are showing declines in export orders.

Robert Koopman, the chief economist at the World Trade Organization, stated in the Bloomberg article that there are fears that we are beginning to see signs of a slowdown in global trade. He cited slowdowns in air and ocean freight as well as auto production as the reasons for the fears.

Koopman went on to point out that we already see a global decline in foreign direct investment which could have more of a long-term impact on trade.

The ISM report was certainly encouraging in that it shows that the U.S. economy isn’t slowing yet, but the key word there is yet. As long as exports continue to decline and the longer the trade wars continue, the more of an impact we are going to see.

I seriously doubt the ISM index can remain above the 60 level for more than a month or two with exports declining. And as long as other economies are weakening, even if the U.S. economy remains strong, exports are likely to decline.

I have stated numerous times that I support President Trump’s decision to tackle the discrepancies in global trade policies. I have also questioned the strategy being employed. Unfortunately, things haven’t changed much in recent months and I look for the consequences of our actions to start hitting soon.

I look for third quarter GDP to dip from the 4.2% growth rate we saw in the second quarter. I also look for the ISM index to dip back below the 60 level in the next few months—unless of course we can reach agreements with Canada, the EU, and China.

About Rick Pendergraft

Rick has been studying, trading, analyzing and writing about the investment markets for over 30 years. He has worked for some of the largest financial publishers in the world and he has been quoted in the Wall Street Journal, USA Today, the New York Times and the Washington Post. In addition, he has been interviewed on Bloomberg, CNBC and Fox Business News. Rick’s analysis process includes fundamental, sentiment and technical analysis. Rick started college as an education major, wanting to teach economics, but eventually changed to majoring in Economics and received a Bachelor of Science in Economics from Wright State University. His desire to inform and educate people is at the heart of his writing.

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