Talking Points
May 09, 2025 | 13:05
No Smoke on the Water
Economics
Economics
At least three developments this week were widely interpreted as turning down the temperature on the trade war, and thus provided modest support for equity prices, bond yields and the U.S. dollar. Probably most important, the U.S. and China managed to agree to talk, without either losing face—some form of negotiations begin this weekend in neutral Switzerland. Second, with much fanfare, the U.S. and U.K. agreed on a preliminary deal to dial down tariffs on metals and autos, perhaps providing a framework for others. And, finally, Canadian PM Carney’s high-stakes meeting at the White House at least set the stage for less fractious relations between the two massive trading partners than the past four months. While there was no white smoke from Washington, as the PM predicted, the calmer tone is a small positive. |
However, while all these steps are indeed incrementally positive, it really doesn’t add up to much progress. The stark reality is that overall U.S. tariffs have barely budged, with the weighted average still hovering at levels no one has seen in their lifetime. And, from our perspective, the U.K. “deal” was arguably bad news. Even with some concessions, Britain still is left with a base-line tariff rate of 10%, and this is for one of the few major economies that runs a trade deficit with America. In other words, all others—including penguins, but excluding USMCA-compliant goods—will be dealing with a minimum tariff rate of 10% for the foreseeable future. And those nations running significant trade surpluses with the U.S. are likely looking at a higher base rate. The U.K. deal normalized the abnormally high base tariff rate—not good. |
Similarly, our big takeaway from the Carney/Trump meeting was the President’s telling response to a journalist question on why Canada couldn’t say or do anything to get tariffs lifted: “It’s the way it is”. And, while words are clearly not policies, the President was decidedly lukewarm on the future of USMCA, seeming to even question whether it need exist. Somewhat offsetting those concerning remarks, he also hinted that Canada may not face any additional measures. So, tariffs on metals and autos are here to stay, as well as on non-USMCA-compliant goods, but that may be it. If that’s where things settle, the economy faces something right between the Bank of Canada’s two scenarios, and perhaps slightly firmer than our current base case projection. Note that Canada remains the single biggest U.S. export destination (Table 1), absorbing US$351 bln in the 12 months to March, ahead of Mexico and the Euro Area (both $338 bln), and miles above China ($139 bln), Japan ($81 bln), Korea ($65 bln) or even the UK ($84 bln). |
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Notwithstanding those dry facts, the market remains understandably focused on the high-wire U.S.-China negotiations. There are plenty of signs that the triple-digit tariff rates of the past month have all but brought trade to a standstill, with the President noting that ships are turning around in the ocean. It’s hard to believe that a full agreement can be reached anytime soon, given the gulf between the goal of balancing trade and the hard reality of a $305 bln deficit with China. However, there is certainly scope for the current trade-debilitating tariffs to be partially pulled back in short order, but it would hardly be cause for big celebration if we land at, say, 80%. The early returns on how various economies are dealing with the first month of the full-on trade war are beginning to trickle in, and the news on the hard economic data is mixed. Starting in the U.S., last week’s jobs figure was firm, giving no obvious sign of strain, while the 4-week average of initial jobless claims has only nudged up to 227,000. This week’s services ISM was surprisingly steady at 51.6, and supply chain pressures actually eased last month. Now all eyes will turn to next week’s CPI and retail sales, but both are expected to post low-drama results—annual inflation is expected to stay stable for headline (2.4%) and core (2.8%), with 0.3% monthly increases for both, while tiny gains are expected for total and ex-auto retail sales. The main point is that the U.S. economic data are hardly flashing serious warning signs, despite the deep dive in many sentiment surveys. This didn’t stop the Fed from cautioning in its post-FOMC statement that there were now upside risks to both unemployment and inflation. On cue, the latest Blue Chip survey shows that the consensus now looks for just 1.2% GDP growth this year (we’re at 1.1%), down a full point since the start of the year, while unemployment is expected to climb to 4.4%, even as inflation has been lifted to 3.2% (from 2.5% in January). That combo has left the Fed in a box so far this year, with rates unchanged since December—much to the deep chagrin of the Administration. Markets have now pushed back the likely timing of the next cut to July 30, and we concur. A variety of East Asian economies reported their trade results for April this week, and the tariffs hung heavy. Vietnam and Taiwan both saw jumps in exports, as firms are still rushing to either get ahead of the possible comeback of outsized reciprocal tariffs, or new sectoral tariffs—Taiwan saw chips and electronic sales pop last month. A significant sidebar was a big appreciation in the Taiwanese dollar this week to around 30/US$, a 6% strengthening in a week and 10% just since early April. The central bank chief said this was not due to U.S. pressure, but it’s quite clear that the Administration is taking a very dim view of currency manipulation broadly. China’s trade results for April were a bit more cut and dried, with the opening tariff shots already cutting exports to the U.S. by 18% y/y. Still, China managed to lift overall exports 8.1% y/y (albeit down from 12.4% in March). The trade surplus still came in at a hefty $96 bln, down from $103 bln the prior month, but the largest April surplus on record. Meantime, on the domestic side, the private sector PMIs stayed above 50 last month for both services and on the composite measure. And, to provide some support for homegrown activity, the PBOC cut the reserve requirement ratio this week by 50 bps to 9.0%. If the resiliency of the Chinese economy is surprising, we’ll note again that exports to the U.S.—while massive in nominal terms at $520 bln (China’s data)—are less than 3% of China’s GDP, compared with Mexico’s near-30% reliance on the U.S. market, or Canada’s 20%. Canada also began to see the first hard economic results for April this week. Our take so far is that while conditions may be holding up a touch better than we expected, it’s still not good. Employment eked out a modest 7,400 gain, but that was flattered by a 37,100 increase in public administration (likely due to election workers). In other words, the economy just saw back-to-back underlying job losses of around 30k, with all of the latest drop in manufacturing payrolls. The spread between Canada’s 6.9% jobless rate and the 4.2% in the U.S. is now a towering 2.7 ppts, matching the widest gap of the past 24 years (aside from some wild results during COVID). Meantime, home sales are slumbering amid the deep economic uncertainty. One major retailer did report that consumers have been resilient so far, albeit against a backdrop of the country’s oldest retailer sadly in the throes of liquidation. In sum, the economy has perhaps held up slightly better than our weak and below-consensus call, but still leaving the Bank of Canada in a position to cut further, with the next meeting in early June very much a live option. |