The data’s still somewhat confusing
As hard numbers claim growth is cruising
But surveys keep showing
That growth should be slowing
And bears think we’re in for a bruising

Another month, another series of weaker than expected PMI/ISM data with limited corresponding weakness in the ‘hard’ numbers.  On Monday, ISM Manufacturing fell to 46.0, basically a point worse than last month and expectations.  The sub-indices were no better with weakness across Prices, Employment and New Orders.  This is hardly the sign of a strong economy.  In fact, we are at levels consistent with recession.  The same story has been playing out internationally, with weakness across virtually the entire Eurozone and weakness in China as well.  In fact, this morning’s bearish risk tone seems to have been driven by the weakness in the Caixin PMI overnight which fell to 52.5 on much weaker Services activity.  At least that is the current story making the rounds.

 

The confusion comes from the fact that the hard data, measurement of actual activity and output rather than surveys of what people or businesses are planning or expecting, remains far better than the Survey data implies.  Consider that the average reading of the regional Fed manufacturing surveys in June was -9.86, a pretty clear indication that manufacturing is in recession territory.  Meanwhile, the Citi Economic Surprise Index remains at a solidly positive 57.5, which is a level consistent with solid GDP growth.

 

So, which is it?  Has the Fed achieved its objective of a soft landing, with inflation heading back to the 2% target while growth continues apace?  Or is the survey data truly descriptive of the future with a more dramatic slowing of growth soon to appear on our screens?

 

Alas, it is very difficult for me to view the total picture and see the soft landing as anything but a tiny probability.  The term ‘long and variable lags’ was created because they are just that, long and variable.  There is no consistency as to the time between the Fed’s policy actions and their impact on the economy, with examples of the adjustment being anywhere between 9 and 27 months.  Arguably, this time we have seen some unusual timing given the starting point of the economy and all the unique policies that were a consequence of the pandemic response.  And as of today, we are 15 months into the tightening cycle, so plenty of time yet to remain within the historical landscape here.

 

For instance, the dramatic rise in interest rates were assumed to have been devastating to the housing market and home builders yet that has not been the case.  Instead, the result that was generally unforeseen, was that the supply of existing homes on the market shrank dramatically as people are now ‘locked into’ extremely low mortgage rates (having refinanced during the ZIRP period) and either cannot afford to, or simply will not give them up.  The result is that housing demand is largely being satisfied by new homes, thus home builders are killing it while consistent housing demand results in higher prices.

 

Similarly, fiscal policy has been pumping money into the economy at a far faster rate than during previous recessions with Congress passing the ironically named Inflation Reduction Act, as well as the CHIPS act and various other spending measures.  At the same time, the student loan forbearance has resulted in millions of people having much greater disposable income than they otherwise would have been able to spend, thus supporting demand.  However, it appears that the student loan situation may be changing after the recent Supreme Court ruling and the debt ceiling deal also included some spending reductions.  The point is that the taps may be slowly turning off in two areas that have been broadly economically supportive thus reducing overall demand and correspondingly economic activity.

 

This week, however, we get some of the most important ‘hard’ data with both the Trade Balance and the employment report.  In fact, I have maintained that NFP is the single most important piece of data currently as its continued strength has been the key reason the Fed has been able to defend its policy choices.  As long as Unemployment remains low, Chairman Powell can point to that and rightly claim that the economy can withstand higher interest rates and the Fed will continue their quest to drive inflation to their 2% target.  This is not an argument for their policies, just an observation that they will not change until there is a sufficient catalyst to do so.  Hence, I continue to watch the weekly Initial Claims data as crucial.  It has already started to move higher, with the 4-week moving average having risen to 257.5K from a low point of 190.5K back in September 2022.  While this number is not recessionary in its own right, the trend is clearly a concern.

 

Ultimately, I remain in the camp that the widely forecast recession is still coming down the tracks, it has just taken the scenic route.  In the meantime, a quick look at the overnight session shows risk is under pressure everywhere with Asian equity markets all in the red and Europe seeing the same thing.  As mentioned above, today’s narrative is about the Caixin PMI printing a weak number, but we also saw weakness throughout Europe in today’s PMI releases.  US futures are also under pressure at this hour (8:00), currently down about -0.5%.

 

Bonds are seeing some haven demand with yields sliding a bit across the continent, somewhere in the 1bp-2bps area, although Treasury yields are essentially unchanged this morning, maintaining the gains from the much higher than expected GDP print last week.  If we continue to see strong economic data, I expect that Treasury yields can head higher still.  The yield curve inversion is now at -105bps, its lowest point during this period and an indication that the market is more accepting of the Fed’s higher for longer comments.  Remember, this remains a very powerful recession indicator as well, and it has been inverted for just over a year at this point.

 

Oil prices have rebounded 2% this morning and are back above $70/bbl after Saudi Arabia indicated they were going to continue at their recently reduced production level and there is word that the Biden administration may tender for more oil to start refilling the SPR.  Remember, though, oil remains far lower than it has been in the past year, so there is plenty of room for it to move higher.  Metals prices are mixed this morning with gold rejecting a sell-off below $1900/oz and both copper and aluminum still trending lower.

 

Finally, the dollar is broadly stronger today but in truth is mixed since I last wrote on Friday.  In the G10, the commodity bloc is suffering most with AUD (-0.45%) and NOK (-0.4%) the laggards although all currencies are softer on the day.  In the EMG bloc, HUF (-0.9%) and BRL (-0.5%) are the laggards with the forint responding to both budget cuts and expectations of central bank interest rate cuts, while the real appears to be tracking the broader risk-off sentiment.

 

On the data front, it is obviously an important week with the following on the docket:

 

Today	Factory Orders	0.8%
	FOMC Minutes
Thursday	ADP Employment	223K
	Initial Claims	245K
	Continuing Claims	1750K
	Trade Balance	-$69.0B
	JOLTS Job Openings	9900K
	ISM Services	51.3
Friday	Nonfarm Payrolls	225K
	Private Payrolls	200K
	Manufacturing Payrolls	5K
	Unemployment Rate	3.6%
	Average Hourly Earnings	0.3% (4.2% Y/Y)
	Average Weekly Hours	34.3
	Participation Rate	62.6%

Source: Bloomberg

 

While everybody will be looking forward to the payroll report, this afternoon’s FOMC Minutes should be interesting as well.  Given the entire skip/pause question, there is heightened interest as to how that conversation played out.  But ultimately, this is all about payrolls this week.  Aside from the Minutes, we hear from two other Fed speakers, NY’s Williams and Dallas’s Logan, with the market still trying to determine just how high higher for longer really means.

 

The funny thing about the FX market is that despite my growing belief that the US is still due a recession, I believe that the dollar may well hold up as Europe and many emerging markets find themselves in the same situation.  As such, the description of, the cleanest dirty shirt in the laundry still applies to the buck.

 

Good luck

Adf