Threats Become Real

Amid a busy month for economic news, a significant policy event occurred: the Section 232 tariffs on imported steel and aluminum went into effect on June 1, 2018. A tariff action of this size has not been seen since the Great Depression. It is likely to be followed by tariff actions specifically targeting China. We have entered a new era in foreign trade.

Tariffs are economically significant, as they can impact both output and inflation. The United States is a net importer, and our economy cannot easily realign to replace all imports with domestic production. Tariffs increase the costs of raw materials and finished goods, and they will eventually flow through to the various price indexes.

The steps taken this week are moderate in scale. However, with each trade action, the prospect of unintended consequences increases. We have not yet taken the step of raising our forecast for inflation, but trade frictions place the risks to the upside.

Key Economic Indicators

Influences on the Forecast

  • Gross domestic product (GDP) for the first quarter was revised slightly downward to 2.2% growth (from a 2.3% initial estimate) after adjusting for inflation. Despite the negative revision, this remains a stronger growth rate than had been anticipated. The revision confirmed strong growth in business investment, which was revised upward to a 9.2% annual pace.
  • Consumer spending grew 4.9% year-over-year in April, exceeding expectations. Nominal personal income grew by a robust 3.8%. We believe the second quarter will be the strongest one for GDP growth this year, led by consumer spending. “Nowcasts” of annualized second quarter growth are very strong; the one produced by the Federal Reserve Bank of Atlanta is well over 4%.
  • The May employment report revealed a headline unemployment rate of 3.8%, matching a low rate last seen in 2000 (and before that, 1970). Hourly wages grew by 2.7% year-over-year, an indication that wage pressures are beginning to emerge. Labor force participation is running above its age-adjusted trend, suggesting a further depletion of slack in the labor market.