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Going It Solo: A Trade Wars Story

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Trade policy overshadowed the otherwise good news about the economy last week.

Trying to forecast trade policy became has become a fool's errand.

The Trump administration allowed the steel and aluminum tariff exemptions granted to the European Union, Canada, Mexico, and Brazil to expire on June 1, only weeks after Treasury Secretary Mnuchin declared that "tariffs are on hold." The administration also once again threatened $50 billion worth of tariffs on Chinese goods, with details expected by June 15. Unsurprisingly, our affected trading partners are readying retaliatory trade measures of their own. The U.S. became isolated at a meeting with its closest G7 allies as they criticized the tariffs with "unanimous concern and disappointment."

The trade measures implemented so far by the Administration should not impact the economy in any meaningful way; we expect only a marginal drag on economic growth and boost to inflation. But, the threat of trade protectionism must be taken seriously as it remains the key short-term threat to economic growth. We worry that even the souring of the mood surrounding trade could begin to impact behavior. And the threat of an all-out trade war is rising, which could potentially trigger a global recession.

Economy set to rebound as we expected

Trade policy aside,

...the data released last week continued to reaffirm our view
 that economic growth will accelerate in the second quarter
and that the Fed will hike rates 25 basis points at this month's meeting. 

Among last week's releases, three stood out. Both personal income and spending for April got the second quarter off to a strong start. Both nominal and real spending exceeded expectations while income fell in line with forecasts. Meanwhile, both headline personal consumption expenditure (PCE) inflation at 2 percent year-over-year growth and core PCE inflation at 1.8 percent year-over-year growth held unchanged in April versus March. Goldilocks remains in the house.

The employment situation report did not disappoint, with much to cheer. Payrolls grew faster than expected, keeping this year's pace of job growth a bit ahead of last year's pace. The headline unemployment rate fell to 3.8 percent for only the second time since 1970 (the other instance occurred during the dot-com bubble). The U-6 underemployment rate (the unemployed, the underemployed and the discouraged) fell to 7.6 percent, its lowest level since May 2001. And average hourly earnings, everyone's favorite punching bag, accelerated to 2.7 percent year-over-year growth in May, up from 2.6 percent year-over-year in April. We expect wage growth to accelerate as the labor market continues to tighten and open positions continue to increase faster than jobs, increasing competition for talented labor.

The ISM Manufacturing Index rebounded in May after declining a bit in April. Manufacturing activity continues to slowly increase. There's more demand, but supply is constraining production. The ISM data was supported by regional Fed manufacturing data which also demonstrated a broad expansion in manufacturing output.

What else happened last week?

Of note, construction spending for April increased more than anticipated and spending in February and March were revised upward. The increase in spending largely stemmed from residential spending, particularly spending on existing structures. While that can be taken as a heartening sign for the economy, the housing market would clearly benefit from greater spending on new structures, particularly single-family homes.

The international environment became a bit calmer after Italy looked to finally form a new government. This removed some risk form the euro zone economy. In recent weeks, risks around the world appeared to be increasing: global economic growth slowed in the first quarter, emerging markets came under pressure, and Italy's political tensions roiled markets. A downshift in global risk presents a welcome reversal of the recent trend, though the global picture has muddled since last year.

What it means for CRE

As the data continues to reaffirm our view of an accelerating U.S. economy, the outlook for commercial real estate (CRE) remains positive. Although we don't think the resurgence in the economy will offset the slowdown in fundamentals that has occurred across property types, it should help prop up fundamentals a bit. CRE capital markets should also receive a bit of a boost, although there too any improvement should be marginal and not represent a change in course.

What we are watching this week

The ISM Nonmanufacturing Index for May should hold near last month's reading but still reflects a solid environment for the service sector in the U.S. The trade balance for April should also remain more or less the same with positives offsetting negatives.

Thought of the week

The combined value of dividends and share buybacks among S&P 500 companies is expected to surpass $1 trillion for the first time this year. 

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