Derek Halpenny, European Head of GMR at MUFG, suggests that the pronounced pessimism that has existed since the turn of the year, in part over fears of a downturn in the US, is slowly fading as the data from the US points to a degree of resilience that market participants have clearly under-estimated.
Key Quotes
“US yields and the dollar are now recovering and we see scope for further dollar gains in March. The main source of concern over the US economy has been that manufacturing weakness was worsening and that this would inevitably begin to impact the US consumer. However, the ISM manufacturing report yesterday pointed to some modest recovery in manufacturing activity. After falling every month since the CNY devaluation in August of last year, the ISM manufacturing index jumped from 48.2 to 49.5, the second month of increase.
ISM Chairman, Brad Holcomb, stated that the report was consistent with a view that the fall in activity was bottoming. This makes sense to us and we guess to the Fed also who continuously speak of the “transient” impact from falling oil prices and the strong dollar. Firstly, investment in mining and exploration structures fell by over 50%in 2015 and there is no way that extent of decline will be repeated this year. That very small portion of the US economy (1-1.5%) still managed to shave about 0.4ppt off total annual growth on a Q4/Q4 basis. Secondly, the strength of the US dollar is also very unlikely to be repeated this year. By the middle of last year, the annual increase for the Fed’s Broad USD index stood at 13.6%. The annual increase to the end of February stood at 8.0% and the 6-month increase was 3%. On a more narrow DXY basis, the annual gain to mid-2015 was 19% while that annual gain is set to drop to zero this week.
So the Fed’s transient argument is valid and the ISM data along with perhaps the durable goods data do suggest that while the manufacturing sector is clearly very weak, it is now showing signs of recovery that will be very encouraging for the Fed.
Today’s ADP employment is likely to confirm continued strength in the jobs market and there must also be an increasing risk that the Beige Book, released this evening, may more explicitly mention signs of wage pressures building. The broad macro wage data is certainly pointing to signs of increased wage growth and hence confirmation of that in anecdotal reports like the Beige Book must surely be approaching.
That would certainly intensify pressure on the FOMC. If the FOMC was true to its word on monetary policy decisions being “data-dependent” a rate increase on 16th March would be a done-deal. The only aspect to hold them back at this upcoming meeting is the concern over broader financial market conditions. But of course those conditions are now improving – crude oil prices are about 30% higher from the low in February, the S&P 500 is 8.2% higher from the February low and has retraced most of the 10.5% drop since the start of 2016.
While the Fed will refrain from raising rates on 16th March, the FOMC will have a difficult job justifying any dramatic reappraisal of the outlook for the federal funds rate. The only justifiable concern can be the drop in inflation expectations but the FOMC has been stressing of late that market measures may not be reliable which given the marked jump in “actual” inflation would appear a valid point.”
(Market News Provided by FXstreet)