‘Yellow flags’ signal cracks forming in Donald Trump’s economy

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Donald Trump has “big” plans for the U.S. economy — a smaller public sector, overhauling global trade so that it benefits Americans and new tax policies that aim to spur growth.

But as the president himself admitted recently, the challenge is getting there, “There’ll be a little disturbance, but we’re OK with that,” Trump told Congress last week.

What that disturbance develops into is the question, and over the past month the economists at Royal Bank of Canada have noticed several “yellow flags” popping up in the data.

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Here are “the cracks forming in the U.S. economy,” RBC chief economist Frances Donald and senior economist Mike Reid say are worth keeping an eye on.

Sentiment is slumping

Consumer and business surveys are flashing growing signs “economic discomfort,” said the economists. The University of Michigan consumer confidence survey fell in January after rising for five months in a row and the Conference Board’s study dropped in December and January after hitting a near record jump in October. The NFIB survey of small business reported that only 15 per cent of businesses were planning on creating new jobs.

However, this is “soft data” and doesn’t necessarily translate into a decline in the “hard data” of consumer spending, they said. What RBC thinks is happening is that lower- and middle-income Americans are struggling with higher interest rates and inflation, while higher-income groups remain in better shape.

The wealthier Americans, who account for a larger share of spending, are the ones to watch as far as the economy is concerned. “A pullback among high-income consumers would merit a shift in our U.S. consumer outlook,” said Donald and Reid.

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A stock market meltdown could trigger such a pullback, and there have been plenty of signs for worry there as tariff threats hike volatility. The American Association of Individual Investors survey recently showed that bullish sentiment had declined to levels seen only in major stock market drawdowns.

A plunging market would create a “negative wealth effect” for higher-income earners that leads to corporate earnings being revised lower, stock portfolios losing value and wealthier consumers cutting back on spending, they said.

Inflation expectations are rising

Inflation was already a concern in the United States, but now expectations are rising, reflected in both consumer and business surveys.

The danger is this could change behaviour both in the economy and stock market, they said.

Government job cuts are showing up in data

The federal government cut 10,000 jobs in February and those numbers are likely to get higher. Planned job cuts measured by Challenger jumped 103 per cent.

The concern is that government cuts will filter through to the broader economy by cancelling contracts and future funding. Some universities, for example, recently announced they are freezing hiring.

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Consumer debt is swelling

American consumers piled on US$56 billion in non-real-estate debt in December and January and most of it was on credit cards, said the economists. That means they are now spending 2.5 per cent of their monthly disposable income on non-mortgage interest payments, a share that could rise as the Federal Reserve keeps interest rates high and costly credit debt mounts. The growing debt burden is already showing up in “hard data” with real personal spending falling by more than 5 per cent from the year before in January, said the economists.

At this point RBC still expects the U.S. economy to pull off a “soft landing” but will watch these “yellow flags” closely in the months to come.

“We surmise it is uncertainty itself weighing on much of these indicators — an uncertainty that could reverse or change — but also risks bleeding into the real economy in more tangible ways if left unchecked,” said Donald and Reid.

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Where the Bank of Canada interest rate goes next is uncertain, because no one knows what Trump and his tariffs will do next, but economists say it’s likely to be lower than the market expects.

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Canada’s central bank cut its key rate to 2.75 per cent Wednesday, warning the economic impact of a prolonged trade war with the United States could be severe.

If tariffs take hold, the bank may have to balance rising inflation with a slowing economy, and many economists think it will come down on the side of weak growth.

Bank of Montreal economists expect three more cuts bringing the rate to 2 per cent.

“Our core assumption is that Canada will be facing some serious tariffs for an extended period of time and that the growth dampening aspects of the trade war will ultimately outweigh the upside inflationary impact, keeping the Bank in easing mode,” wrote Douglas Porter, chief economist for BMO Capital Markets.

• Today’s Data: Canada building permits, U.S. producer price index
• Earnings: Transat AT Inc., Empire Co. Ltd.

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Today’s Posthaste was written by Pamela Heaven, with additional reporting from Financial Post staff, The Canadian Press and Bloomberg.

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