Chief economist update: US recession in the offing

"On June 10th, the United States will impose a 5% Tariff on all goods coming into our Country from Mexico, until such time as illegal migrants coming through Mexico, and into our Country, STOP. The Tariff will gradually increase until the Illegal Immigration problem is remedied... which time the Tariffs will be removed. Details from the White House to follow [sic]."

Donald Trump tweeted this renewed call to war on Mexico on Thursday (May 30) that practically made a mockery of the US-Mexico-Canada Agreement (USMCA) - the one that replaced NAFTA only seven months before (1 October 2018).

Partial details inform the tariff rate on all US imports from Mexico would then increase by five percentage points the following month and every month thereafter until reaching 25%.

This sent US equities lower the next day and last trading day of May - Dow (1.41%), S&P 500 (1.32%), Nasdaq (1.51%), Russell 2000 (1.35%). Meanwhile, 10-year US bond yields closed at 2.14% - the lowest since January this year - and the VIX index jumped by 18.2% on the day.

Wall Street's reaction is to be expected particularly given Trump's latest bombshell comes in the midst of its escalating trade war with China.

According to Bloomberg, Beijing has readied plans to restrict rare earth exports to America with Reuters reporting: "China's Commerce Ministry ... will draft a list of foreign companies, organisations and individuals that it deems "unreliable" for harming Chinese companies."

While I consider Trump's latest battle tweet a stroke of genius, it puts the onus and the expense on Mexico to pay for measures to stop illegal migrants coming to America and, at the same time, prove that his admonitions to the Fed to cut interest rates were correct all along, their hefty prices to pay for the looming US recession.

The yield differential between the yield on US 10-year Treasuries and 3-month US bills - the best predictor of US recessions according to a study conducted by the Federal Reserves of Cleveland and New York - have gone more negative and by longer compared with its inversion in March this year.

So much so that, according to the CME FedWatch Tool, the probability of Fed rate reductions by December this year have increased while the odds of the Fed maintaining the current 2.25%-2.5% Fed funds rate dropped to a mere 4.9% (from 23.1% a week ago) and the probability of two rate cuts to 1.75%-2% have risen to 35.1% (from 26.8% a week earlier and 10.6% a month earlier).

TARGET RATE (BPS)                                            PROBABILITY(%)
                                                NOW *                    1 DAY                 1 WEEK                 1 MONTH
                                                                             31-May-19           24-May-19                2-May-19
100-125                                 1.30%                       1.00%                   0.00%                      0.00%
125-150                                10.00%                      8.60%                   0.80%                      0.10%
150-175                                27.50%                    25.70%                   7.30%                      1.50%
175-200                                35.10%                    35.60%                  26.80%                    10.60%
200-225                                21.20%                    23.30%                  41.90%                    37.40%
225-250 (Current)                   4.90%                     5.80%                   23.10%

Read more: USFedMexicoTrumpAmericaChinaCountryFederal Reserves of ClevelandNew YorkSTOPBeijingBloombergCME FedWatch ToolCommerce MinistryDonald J. Trump@realDonaldTrumpDowIllegal ImmigrationNAFTANasdaqReutersRussellS&PTariffsThursdayUnited StatesUS-Mexico-Canada AgreementVIXWall StreetWhite House
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