Yesterday brought rather a marked change in views on the US economy and much of it related to this from the Institute for Supply Management or ISM.
The New Orders Index remained in contraction territory, registering 44.6 percent, 2.8 percentage points lower than the 47.4 percent recorded in July. The August reading of the Production Index (44.8 percent) is 1.1 percentage points lower than July’s figure of 45.9 percent.
As you can see the ISM reported a fall in manufacturing production and a larger fall in new orders suggesting that the outlook for production was also poor. This set off various recession klaxons in spite of the fact that according to ISM the headline reading was positive for the overall economy. Just as a reminder 50 is the benchmark for manufacturing itself so actually they are implying quite a relative decline for manufacturing over time.
“The Manufacturing PMI® registered 47.2 percent in August, up 0.4 percentage point from the 46.8 percent recorded in July. The overall economy continued in expansion for the 52nd month after one month of contraction in April 2020. (A Manufacturing PMI® above 42.5 percent, over a period of time, generally indicates an expansion of the overall economy.)
On a conceptual basis these sentiment indicators have a problem and it is an irony. They are used as a forerunner or leading indicator but adding in factors such as employment and backlogs and deliveries rather neuters the headline for this. We have seen it in the past with the Markit version of this and we saw it hit the ISM yesterday as the generally indicates an expansion rather collided with this.
Fiore continues, “While still in contraction territory, U.S. manufacturing activity contracted slower compared to last month. Demand continues to be weak, output declined, and inputs stayed accommodative. Demand slowing was reflected by the (1) New Orders Index dropping further into contraction, (2) New Export Orders Index contracting slightly faster, (3) Backlog of Orders Index remaining in strong contraction territory, and (4) Customers’ Inventories Index at the ‘just right’ level.
I do not know about you but I have the feeling that the Goldilocks style situation for inventories is about to change with the demand issues preceding it. Maybe even more so for employment which we are told rose.
The Employment Index registered 46 percent, up 2.6 percentage points from July’s figure of 43.4 percent.
The downbeat message was reinforced by some of the specific comments from manufacturers.
“A noticeable slowdown in business activity. Staffing and production rationalization has been triggered. Previous optimism about future growth has been dashed.” [Chemical Products]
Stock Markets
It is often dangerous to say that a piece of economic data caused a stock market move.But I think it was a contributing factor to an impact on something I have warned about which is the increasing narrowing of the US stock market. The “Magnificent Seven” has rather morphed into a De La Soul style “Three is the Magic Number”
Nvidia plunged 9.5% on Tuesday, wiping nearly $300 billion off the chipmaker’s market cap and pulling chip stocks down with it………. The VanEck Semiconductor ETF (SMH), an index that tracks semiconductor stocks, was down 7.5%, its worst day since March 2020. ( CNBC)
In a way it is live by the sword and then die by the sword. Or if you prefer when a trade is this crowded the exit door becomes very small.
“I could tell you my adventures—beginning from this morning,” said Alice a little timidly; “but it’s no use going back to yesterday, because I was a different person then.” ( Lewis Carroll )
Also the impact became international with what seems to be the swing market these days Japan the most affected.
Japan’s Nikkei 225 fell 4.24% to close at 37,047.61, while the broad-based Topix dropped 3.65% to 2,633.49. Both indexes saw their worst one-day loss since the Aug. 5 sell-off. ( CNBC)
The Federal Reserve
It will be noting the above news although opinion will be divided as to whether it is more worried about the financial economy ( stock market) rather than the real one as represented by manufacturing. One area it has been clear about is the labour market and I note this from an opinion piece in the Financial Times by Andrew Law.
Crucially, in each instance of a soft landing, the Fed acted before the labour market had deteriorated meaningfully. In these cases, the unemployment rate had increased by only 0.1 to 0.3 percentage points before the Fed began reducing rates. Whatever vagaries have driven the near 1-point increase in this cycle, the precedent is clear.
One cautionary note is that the Financial Times seems to be running a sequence of opinion pieces calling for cuts in US interest-rates. Indeed rather large cuts.
Most participants on the policy-setting Federal Open Market Committee estimate that the neutral interest rate that does stimulate or restrict the economy is in the 2.5 to 3.5 per cent range versus the current 5.25 to 5.50 per cent.
Previously it was the former head of the New York Fed calling for cuts of around 2%.
Crude Oil
The potential slowing of the US economy was also a factor in this move.
West Texas Intermediate had dipped below $70 per barrel earlier today, with Brent crude sliding below $74 per barrel, after Libya’s rival governments reached a deal to appoint a governor to Libya’s central bank, which would resolve the dispute that prompted the shutdown of oil fields and export terminals last month. The shutdowns had decimated the country’s output of some 1.2 million barrels daily. (oilprice.com)
Whilst the resumption of supply from Libya was no doubt a factor we are seeing rather low oil prices at the minute considering there is a war going on in the Middle-East. These are the lowest levels we have seen this year and it is hard not to think that fears over the world economy are in play.
Comment
This morning has brought news from a situation I have been warning about for several years now and most recently on Monday.
China Mulls Cutting Mortgage Rates In Two Steps To Shield Banks ( @LiveSquawk)
I see that as a confirmation that there is what Taylor Swift would describe as “trouble,trouble,trouble” in banking and property markets there.Whilst the Federal Reserve rarely takes much note of events abroad it may be worried about US exports.
But there is a counterpoint to the cheerleading for US interest-rate cuts and it too was in the ISM report.
The Prices Index registered 54 percent, up 1.1 percentage points compared to the reading of 52.9 percent in July.
This is why I think a much more cautious approach is more sensible. A trim rather than a slash as the risk is that the outlook could be rather stagflationary.