Focus on Trade – August 2019 Edition

Trade negotiations with China completely dominated the other economic news this week. Mortgage rates dropped to the lowest levels in about three years early in the week, but later reversed direction. After very large swings, rates ended just a little lower.

Last Thursday, President Trump announced that the U.S. will impose additional tariffs of 10% on $300 billion of goods imported from China beginning on September 1 because trade officials feel that China has not followed through on prior commitments. Over the weekend, China responded by allowing its currency to weaken to gain an edge in selling goods to other countries (see below). The response on Monday to the apparent escalation in the trade war was massive declines in global stock markets and bond yields, including U.S. mortgage rates. Over the course of the week, however, investors gravitated toward the view that these latest developments likely will not have much impact on the ultimate outcome of the trade negotiations, and the stock and bond markets reversed most of their movement.

Prior to this week, the primary tool used by the U.S. and China to gain leverage in the trade talks has been raising tariffs on imports. U.S. tariffs act like a tax on consumer goods from China, and the resulting higher prices reduce demand. This latest increase would be particularly influential because companies will be planning where to source goods for the holiday shopping season. Since tariffs slow the outlook for economic activity, they are positive for mortgage rates.

The effect on mortgage rates of China’s weakening currency (the yuan) is a bit more complex. As anyone from the U.S. who travels to another country has experienced, a stronger dollar makes foreign purchases cheaper. Similarly, the weaker yuan means that imports from China are less expensive for U.S. consumers, so this partially offsets the higher tariffs. In short, a stronger dollar allows U.S. consumers to purchase Chinese goods at a better price, but the downside is that it leads to more imports from China and fewer exports to China. This hurts the U.S. manufacturing sector and displeases U.S. trade officials.

The services sector accounts for about 85% of U.S. GDP growth, while the manufacturing sector is responsible for the remaining 15%. The primary monthly report for the services sector is the ISM national services index, and the latest reading was not encouraging. Rather than an expected small increase, the index declined to 53.7, the lowest level in the three years. Even with this month’s weaker results, though, the reading above 50 indicates that the sector is still expanding.

Looking ahead, the Consumer Price Index (CPI) will come out on Wednesday. CPI is a widely followed monthly inflation report that looks at the price change for goods and services. Retail Sales will be released on Thursday. Since consumer spending accounts for about 70% of all economic activity in the U.S., the retail sales data is a key indicator of growth. Housing Starts will come out on Friday. In addition, news about the trade negotiations could influence mortgage rates.

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