Forecaster Jim O’Sullivan on Tariff Headwinds and Second-Half Slowing

With trade tensions escalating and a global slowdown underway, many are left wondering if recession is near. Financial Sense Insider spoke with Jim O'Sullivan, chief economist at High Frequency Economics, whom MarketWatch named one of the most accurate economic forecasters in America, to get his take on tariffs, inflation and the overall economic outlook (see Most Accurate Forecaster Sees 'Fairly Strong Evidence of Slowing').

Impact of Tariffs on Economy

Though President Trump claimed America's strong first quarter GDP number was due to tariffs, O’Sullivan noted this was true in part but one has to keep in mind that most U.S. economic activity is domestically oriented and not based on trade.

The trade deficit with China went down in the first quarter after going up in the second half of last year, O’Sullivan added. This alone does add statistically to GDP growth, but total industrial production was weak in the first quarter, and manufacturing output was down in the first quarter.

“When you stand back and look at the whole picture, I don't see how you can argue that trade really added to growth in the first quarter,” O’Sullivan said. “When you look at the full effect on production, I think most economists would say it's negative.”

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Second Half Slowing

Though tariffs have likely been a drag on growth overall, O'Sullivan doesn't see the U.S. economy moving into recession in 2019 with a relatively strong jobs market and strong payrolls.

He does expect some slowing over the second half of the year, however, and projects growth to slip down slightly to 2.5% for the second quarter and 2% for the third and fourth quarters.

“When we go through the factors that are driving the economy, certainly the fiscal stimulus from last year's tax cut should be fading in 2019,” O’Sullivan said.

“Clearly, we have seen a weakening in export growth as well. And that's a big part of the story of why manufacturing is looking as weak as it is right now. There's a fairly strong case that there is some slowing underway, notwithstanding that first quarter number, which was a surprise on the upside.”

Inflation, the Fed and Tariffs

O’Sullivan posits that price increases from tariffs will be felt mostly by U.S. businesses and consumers. April Chinese import price numbers were down year-over-year 1.1%. For prices to fully offset the tariffs, the decline would need to be about six percent, O’Sullivan stated, equating to a little over $30 billion in tariffs on $500 billion in imports.

$30 billion in tariffs is one-sixth of a percent relative to $20 trillion in GDP, so tariffs have possibly added a tenth of a percentage point to the Consumer Price Index (CPI) out of that two-tenths increase in costs. These are not huge costs, O’Sullivan noted, though we are slated to see an increase in tariffs on the second $200 billion tranche go from 10 percent to 25 percent, adding another $30 billion, potentially doubling the effect.

The Fed likely wouldn’t see inflation coming from tariffs as a positive, O’Sullivan noted, but he doesn’t expect rates to be raised until there’s a sustained uptick in inflation above 2%. In fact, market participants have significantly raised the odds of one to two Fed rate cuts in the second half of 2019 with the Fed's own James Bullard saying a rate cut may be 'warranted soon'.

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