Viewpoint
July 18, 2025 | 14:18
The Economic Mood in the U.S. Continues to Brighten
Economics
Economics
Economics
Economics
Economics
Economics
Economics
Economics
The Economic Mood in the U.S. Continues to Brighten |
| The worst fears over the shock to the labor market and inflation from tariffs have not yet materialized. This is helping to support a rebound in consumer and business sentiment from the lows seen in April and May, despite sizable fresh new tariff threats against many of America’s biggest trading partners effective August 1. Economic surprises, while still net negative, have turned a corner over the last couple of weeks and appear to be leveling off (Chart 1). Compared to a month ago, we have seen improvement in the direction of travel from consumer and business surveys, retail sales, initial and continuing jobless claims, industrial production, and housing (Chart 2). |
| The manufacturing rebound was one of the biggest highlights of the week in my opinion. The Empire State manufacturing index jumped to a positive 5.5 in July, its first positive reading since February. The Philly Fed index made a similar leap to 15.9 in July, its first positive reading since March and highest level since February (Chart 3). These upbeat early reports on regional manufacturing activity foreshadow another month of improvement in the national ISM Manufacturing PMI closer to the breakeven level of 50 from a contractionary 49 in June. June industrial production beat consensus expectations too, increasing at a 4.0% annualized pace, racking up solid monthly gains in primary metals, petroleum products, furniture, machinery, and apparel manufacturing last month (Chart 4). U.S. manufacturing production has been on a general upswing since last December, after two consecutive years of general contraction. The turn to U.S. protectionism and sharp increase in tariff rates on nearly all major trading partners may be having some of its intended effect of shifting more manufacturing production to the states from abroad. It’s still too early to know for sure. The move to cut a percentage point from the Fed funds target rate last year, the weaker U.S. dollar, and two years of languishing production are also likely important contributors to the manufacturing recovery. Industrial production is on track to increase about 1.6% Q4/Q4 this year, the best performance since 2022. This week’s data increase the upside risks to our call. Some economists quickly penciled in a recession this year after the April 2nd tariff announcement, but we have never been in the recession camp and so far that has been the right call. Economic and financial conditions are looking better today than they have in months, but downside growth risks continue to fester in the second half of the year. We will likely see more tariff uncertainty and shocks in just a couple of weeks. The Supreme Court has just greenlighted the President’s plans for significant federal government layoffs, and of course mass deportations loom. Tariff pass-through has been delayed but that doesn’t mean it will never arrive. CPI inflation was remarkably mild in the second quarter, rising at only a 1.6% annualized pace. That gave consumers some breathing room to continue spending as real disposable personal income growth firmed and the unemployment rate remained low. But once the tariff shock fully arrives, we think CPI inflation could still significantly increase from the current mild pace. Consumers today are likely stockpiling purchases like businesses have, bracing for the inevitable inflation shock. If so, the spending let down could be just as dramatic when it hits. We welcome the “Good Vibrations” from manufacturers and consumers this summer but recognize the fall and winter could look quite different. |
Inspecting Prices for Tariff-prints |
| June’s consumer, producer and import price indices were released this week. We combed the statistics for signs of tariffs. The ‘collected’ average tariff rate was 9.7% in the month and rising, well above last year’s 2.4%. The CPI for goods increased 0.3% in June or at a -0.4% annualized pace since January (tariffs started increasing in February). Food at home rose 0.3% and 1.4% annualized, with energy commodities up 1.0% but still down 19.1% annualized. Core goods prices increased 0.2% or just 0.8% annualized, as tariff pressures haven’t bubbled to the surface yet. But they’re there, scattered below the surface. For example, among the price categories with high import content, window and floor coverings along with other linens were up 4.2% in June alone. This was the largest monthly move in 27 years of data, which was also the extreme registered by appliances (up 1.9%) and (non-TV) video equipment (up 4.5%). Toys were up 1.8% in June after 1.3% in May, recording the second-largest two-month jump in 48 years of data. But these and other less extreme tariff influenced price hikes were still not widespread enough, or collectively not large enough, to counter the sea of calmer prices elsewhere. At the factory gate, finished core consumer goods prices were up 0.2% in June and 3.3% annualized since January. The latter is just a little elevated. Further up the production pipeline, for all goods, the impact of higher priced imported inputs is more noticeable. Materials for manufacturing are up 6.1% annualized over the past five months and 17.6% for durable goods. But these pressures have yet to make their way downstream. But at the border, imported consumer goods prices (not including automotive items) were up a large 0.5% in June (seasonally adjusted), the second-largest leap in the past 11 years. To what extent will retail prices be influenced? The impact of U.S. tariffs on U.S. consumer prices is likely being delayed or muted by several factors. Domestic importers and foreign exporters could be absorbing the tariffs via narrower profit margins. The duties have evolved in an erratic fashion and are still (barely) in single digits overall. Firms could be temporarily taking the hit until the tariff landscape becomes more stable and the average rate itself becomes more onerous (the recent tariff ‘letters’ are pointing to above 20%). Meanwhile, this strategy is turning out to be more painful for foreign firms given the depreciation of the U.S. dollar (the narrower margins are being translated into even fewer local currency units). Imports rocketed to a record high in March, capping a stockpiling frenzy to front-run tariffs that saw real imports grow more than 80% since the election. It was going to take some time to deplete these stockpiles, permitting pre-tariff selling prices to persist. Finally, some multinational consumer product companies are using the occasion of U.S. tariffs to lift their global prices. As such, U.S. prices don’t have to rise to reflect the full impact of tariffs because narrower U.S. profit margins can be offset by wider non-U.S. margins. And raising prices globally also provides some political cover for lifting U.S. prices. It’s uncertain how long these delaying and muting forces can last, particularly amid a rising (collected) average tariff rate. It might still be only a matter of time before consumer prices succumb. |
Consumers: What Trade War? |
| Someone forgot to tell American shoppers there’s a trade war going on. After earlier front-running to beat tariffs, retail sales were widely expected to nearly stall in June. Instead, they jumped 0.6% on broad-based strength. The measure that feeds into estimates of personal spending rose nearly as much and is up 5.0% in the first half of the year compared to the same period last year. And, if you think the increase was inflated by tariffs, note that core consumer goods prices have barely risen this year. While overall consumer spending (including services) has cooled a little, it remains healthy—up 2.7% in the five months to May from the same time a year ago. Demand for durable goods is 5.4% higher, led by new automobiles, which partly reflects buyers racing ahead of tariffs. Spending on services (the sector least affected by tariffs) is up 2.2%, weighed down by recreation services (amid soggy consumer confidence) and accommodations (amid fewer foreign tourists). Overall, consumer spending likely picked up moderately to a 1.6% annualized rate in Q2—about a percentage point slower than the quarter-century average, but likely good enough to push real GDP forward at a similar pace following the previous slight contraction. Apart from tariff front-running, several other factors are helping households. Despite less hiring, unemployment remains low. Outside the federal government and tech sector, layoffs have been limited, keeping wages flowing. As a result, personal income is up a healthy 4.5% in the past year to May. Real income growth is solid at 2.1%, aided by some moderation in inflation amid limited tariff pass-through. Meanwhile, the rollicking equity market is juicing wealth. And, don’t forget that even though policy rates are moderately restrictive, household debt service costs have plateaued at around 11% of disposable income, which is slightly below the five-year pre-pandemic norm. Considering that some demand was pulled forward and that the trade war will likely lift inflation and unemployment moderately, consumer spending is expected to slow somewhat in the second half of the year. But this should mark the low point in the cycle, paving the way for an upturn in 2026 as the Fed resumes easing and trade tensions settle down. |
