Below trend growth to continue
The recent ramp up in Fed rhetoric aimed at putting the market on the scent of an imminent Fed funds rate hike took another blow last night following a sharp drop in the August ISM non-manufacturing index.
The recent ramp up in Fed rhetoric aimed at putting the market on the scent of an imminent Fed funds rate hike took another blow last night following a sharp drop in the August ISM non-manufacturing index. The index fell over 4 points to 51.4, way below the small pullback to 54.9 from 55.5 expected by consensus. Details in the report were also disappointing with business activity falling 7.5 points to a 6½ year low while new order tumbled 9 points to 51.4, its lowest reading since February 2010. This was the third consecutive key US data release to disappoint in less than five days, following the softer than expected employment report and ISM manufacturing survey last week. Ten days ago, the OIS market was pricing a probability of September hike at 45% while December was at 81%. Today September is priced at 24% while December is at 61%. Recent data releases reinforce our view that the Fed will stand pat in September and hike December assuming data and financial condition remain supportive.
Ahead of the ISM data release markets were relatively quiet and reaction to the data was consistent with what you would normally expect. The USD was sold across the board, core global yields rallied and while US equities initially traded softer, the prospect of fed hikes been kicked further than the road eventually helped all three major US equity indices close the day in positive territory. Meanwhile, European equities ended in the red, unable to benefit from the rebound in US equities.
Looking at currencies in more detail, the NOK (1.66%) and NZD (1.52%) are at the top of the leader board. Notably, the NZD has made new highs for the year and while a softer USD was one factor, the Kiwi was also boosted by another solid GDT auction with the average price index rising 7.7% from the previous event. Incidentally our NZD FX strategist also notes that the NZD TWI is trading at its highest level since April 2015 and it is now close to levels where RBNZ intervention has previously come onto the radar.
Not to be outdone the AUD has also been one of the top performers against the USD. While much of the gains triggered after yesterday’s better than expected government spending contribution to Q2 GDP growth (0.5% vs 0.2%) were reversed in the early part of the overnight session, reaction to the ISM number has helped the AUD move past yesterday’s high of 0.7654 and now a 77 handle looks well within reach with the currency currently trading at 0.7688.
Looking at other data releases, the Fed labor market index showed a drop of 0.7% in August, partly reversing the rise in July and remains consistent with the unchanged US unemployment rate.
Australia’s Q2 GDP numbers are due out today at 11:30am (AEST).Yesterday’s better than expected Q2 government spending figures were only partially offset by the softer than expected net export numbers. Overall government spending is now set to contribute around 0.5% points to GDP growth, compared to NAB’s previous expectation of 0.2%. In contrast net exports are now seen to detract 0.2% points to GDP growth compared to an estimated flat contribution previously.
As a result of yesterday’s GDP partial releases, NAB and the market upgraded their forecast for today’s Q2 GDP growth print. In line with Bloomberg’s survey, our economists now expect Q2 GDP to come at 0.6% q/q. That said, our economists also note that there is potential for an upward surprise given a probable downward revision to Q1 GDP (likely to be 0.9% q/q from the originally released stellar 1.1% print). If so, a better than expected Q2 GDP print could well be the trigger for the AUD to trade back with a 77 handle, a feat not achieved since 18 August.
Later in the day we should also get an update on China’s FX reserves. The consensus is for reserves to decline to $3.194trn in August from $3.201trn in July. The decline in CNY in August and the expected trade surplus of $58.5bn suggest capital outflows remain a prevailing theme in China.
Moving onto Europe, Germany releases its July industrial production figures and the market is looking for a pullback to 0.1% from 0.8%. UK industrial production (July) is also due out (-0.2% exp) and they should serve to confirm or deny the pullback suggested in the July PMI numbers. That said and perhaps importantly for the GBP, BoE Carney along with other BoE officials are scheduled to speak in Westminster and no doubt the market will be looking to see if the Governor will maintain its strong easing bias, particularly given the better than expected data of late.
The July Jolts report and the Fed Beige book are due for release in the US and the Bank of Canada also meets tonight. While a no change by the Bank is broadly expected, the market will be eyeing if the bank is more concerned about the recent low inflation print or relaxed given reasonable activity and labour market data.
On global stock markets, the S&P 500 was +0.30%. Bond markets saw US 10-years -6.16bp to 1.53%. In commodities, Brent crude oil -0.08% to $47.36, gold+1.9% to $1,351, iron ore -0.1% to $59.16. AUD is at 0.7687 and the range since yesterday 5pm Sydney time is 0.7616 to 0.7684
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