US: No respite from Trump for markets - Rabobank

According to analysts at Rabobank, the appointment of Mr. Kudlow as US economic adviser would bring some stability back into the ranks of the White House, but that now proves wishful thinking.

Key Quotes

“According to the Washington Post, President Trump may seek to sack H.R. McMaster, the Presidents’ national security adviser – though this rumour was denied by White House staff. Moreover, the US Special Counsel has subpoenaed the Trump business for ‘documents related to Russia’, with details of the news not much more specific than that. While still vague at best, the subpoena does bring the investigation yet another step closer to the President. Markets certainly didn’t like the added uncertainty. The S&P500 erased its gains from the morning session and closed -0.08% down. The Dow Jones, too, shed most its morning gains, but managed to hold on to a modest +0.47% on the day. This mood spread to the Asia-Pacific region, with Chinese and Japanese indices down roughly -0.5% to -0.6% on average.”

“An initial phone conversation between US Secretary of Commerce Wilbur Ross and EU Trade Commissioner Cecilia Malmström on the US steel tariffs failed to bring much optimism either, and talks between the two are expected to continue in the coming week as the European Union tries to seek an exemption from the US import duties.”

“And although the recent Trump turmoil is keeping markets watchful, the US industry generally stays positive, as we saw in both the Philadelphia Fed’s business outlook survey (+22.3) and the New York Fed’s Empire State manufacturing survey (+22.5). The Philadelphia Fed's survey pointed to continued optimism, yet slightly slowing momentum. Business activity remains strong across the Pennsylvania area, and companies remain optimistic about the coming months. An increasing number of businesses is reporting growth in new orders, pointing to ongoing strong demand. In fact, the number of unfilled orders is increasing, as are delivery times, suggesting that the production is struggling to keep up with current demand – a factor that could prove inflationary.”

“The production may be falling behind demand due to a lack of labour supply. A large majority of the survey respondents claimed to have difficulties finding personnel, due to labour shortages but mostly because the available supply of labour doesn't have the required skills for the job. In order to attract workers, 50.7% of firms reported that they are increasing wages and benefits. This, again, could prove inflationary if it translates to broader wage pressures. That said, the fact that firms are particularly looking for workers with specific machine and tool skills could mean that wage increases remain concentrated in a small part of the labour force.”

“Another challenge firms are facing is a squeeze in their margins. Most respondents saw an increase in cost pressures. Respondents to the Empire State survey from neighbouring New York Fed confirmed the rising input prices, with the prices paid component of that survey at a multi-year high. Moreover, there were widespread expectations amongst the businesses in New York State that prices of materials and inputs will continue to increase in the coming months. The shrinking margins, combined with strong demand from customers, could lead to some price increases being transferred to clients, which would add to inflationary pressures.”

“So all-in-all, there are various signals in the underlying survey results that some inflation may be building up. So why then, is this not fully showing in PCE inflation? As we also noted in our FOMC preview, economists at the San Francisco Fed have argued that cyclical inflation is actually already at, or above, the Fed's 2% target, while acyclical factors are holding it back. Assuming that this is true, the FOMC may already be content with core PCE inflation rates in the range of 1.5 to 2.0%. And now that the output gap has closed –or is at least about to– the tolerance for the FOMC to allow an overshoot in procyclical inflation to correct for ‘temporary factors’ has diminished.”