Business sentiment has deteriorated notably over the last quarter and poses one of the biggest risks to our forecast of a soft landing for the U.S. economy. Trade tensions are starting to pose a significant risk to business confidence, and this uncertainty has, in part, already caused investment spending to slow. Business sentiment is at the top of our watchlist going into the second half of the year.
Trade tensions are not a new feature of the landscape, and businesses have been dealing with tariffs, ongoing trade negotiations and the looming expectation of an economic slowdown for some time now. Yet in the last quarter, these clouds seemed to have gathered into a storm. The escalation of trade tensions is undeniable, and in May it spread from the immediate threat of greater tariffs on a broader range of Chinese goods to tariffs on Mexico. Critically, the global growth outlook has dimmed as well. Both the Fed and the ECB have signaled a willingness to ease monetary policy, but it is unclear whether one or even several rate cuts will ease the uncertainty for businesses associated with mounting trade-related conflicts.
The ISM Manufacturing Index, which had been notably strong since the 2016 election and started the year at 56.6, dropped to 52.1 in May, its lowest since October 2016, although it is still above the 50/50 boom/bust threshold. Early regional indicators for June show an even steeper drop, although it will be important to see if this feeds through to the national sentiment measure. Spending on business investment has also slowed, as seen in the monthly capital goods shipments data. The euphoria of 2017 tax reform is fading quickly.
We will be watching both the ISM manufacturing indicator and monthly core goods shipments as high-frequency indicators of businesses’ appetite to invest.
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