ITR Experts Say: Tracking Tariffs and the 10-Year Yield

It was a largely calm first four months of 2019 after a rather hectic close to 2018. Late last year, the US stock market was flirting with bear-market territory, the government was entangled in a shutdown, and a dark cloud of uncertainty cast a pall over the general economic environment. At the start of the new year, we at ITR noticed a definite increase in caution among our consulting clients as well as the audiences at our presentations.

However, as 2019 wore on, things seemingly calmed down: US-China trade negotiations cooled, the stock market slowly recovered from the damage done at the end of 2018, the US unemployment rate compressed lower and lower, and we were even greeted with a better-than-expected first-quarter GDP figure.

Our full complement of leading indicators never stopped signaling a 2019 cooling-off for the US economy, but things were looking calm on the surface, and some were likely lulled into thinking the worst was behind us. That was before US-China trade tensions flared up again in early May, ratcheting the situation up to a new level. After months of calm and generally positive remarks regarding the ongoing negotiations, the surprise escalation triggered a noticeable selloff in US and global equities alike while sending bond yields lower.

What we know:

• The US raised import tariffs to 25% from 10% on products included in last September’s List 3 tariffs, totaling $200 billion worth of goods. Tariffs applied to Chinese goods now total $250 billion.
• The tariff increase took effect May 10 at 12:01 a.m. EDT. US-bound freighters that departed China before the deadline face the prior 10%.
• China responded in kind, announcing retaliatory tariffs on US goods totaling $60 billion to take effect June 1. Tariffs applied by China to US goods now total roughly $110 billion.
• The Office of the US Trade Representative also announced a June 17 public hearing to deliberate over applying 25% tariffs to an additional $325 billion in Chinese goods. If implemented, this final round would affect cellphones and laptops and could be the most visible yet to the US consumer.

For an early evaluation of the latest trade developments, a look at the bond market can prove helpful. The US 10-year Treasury yield has slumped as a result, sitting at 2.41% at the time of this writing. Investors are gravitating back towards haven assets as uncertainty ramps up. US government bond yields have been on a general downward trajectory since topping out at 3.24% in early November.

Furthermore, the US Treasury yield curve briefly inverted – that is to say, the yield on a 10-year note fell below the three-month Treasury yield – typically an ominous sign for future economic conditions. This would suggest that investors have adopted a generally pessimistic view of the developing trade situation and its possible negative impact on growth as they shift more money into the bond market.

Global yields are retreating as well; the yield on 10-year German government bonds, a bellwether for the European bond market, slipped back into negative territory to its lowest level since September 2018. The rate-of-change signaling from the bond market is clearly negative and aligns with our other leading metrics and outlook for ongoing business cycle decline in the US this year.

Business leaders: You need to be tracking not only tariffs but also your rates-of-change to see what these shifting trend lines mean for you specifically. Our proprietary and market leading indicators that look a year or more ahead of the US business cycle should start to form lows as we transition through the summer months. If the stress generated from the trade dispute goes beyond financial markets and proves to be more than the US business cycle can bear, we will see it play out in the data and keep you informed.

Connor Lokar
Economist