Soft survey data dominated FX market pricing last week following a substantial downturn in the US ISM manufacturing index on Tuesday.
The index, once described by ex-Fed chair Alan Greenspan as the best indicator to judge US monetary policy should he be stranded on a desert island, fell to a decade low as US-China trade tensions began to take their toll.
The export sub-index fell to its lowest reading since April 2009 at 41.1. If the contraction is sustained it would mark an annualised drop in exports of around 20%, as estimated by Pantheon economics.
Even though the manufacturing sector is a small component of the aggregate economy, the increased pressure from tariffs on US data in September was notable and set the tone for the week.
This was compounded on Thursday with the release of the ISM non-manufacturing index, which marked another nasty negative surprise in US data. The 3.8 point drop in the headline figure from 56.4 to 52.6 saw September post the lowest reading since August 2016.
More worrisome was the employment sub-index fell to its lowest point since February 2014 at 50.4. The drop in services employment shows firms are almost indifferent in their hiring decisions now and the reading is consistent with payroll growth of around 50,000 jobs in the coming months.
That isn’t even the worst part…
The ISM sub-index has consistently overstated the payroll number thus far in 2019, suggesting the torrid zero mark may not be far away.
Should the US labour market extend its loss of momentum and begin to unwind at such a dramatic pace, the Fed’s resolve will be tested and the prospect of 100 basis point cuts in 2019 will only increase. Some of the pressure was released on Friday afternoon with a steady NFP release of 136,000, but it must be noted that the ISM leads the downturn in payroll growth by around 2-months.
On Friday, the unemployment rate fell to the lowest point since December 1969 at 3.5%, but earnings failed to tick up.
Record low employment rates coupled with stagnant wage growth underlines the fragility in employees bargaining power, although this cannot be confirmed from just one data point
On average, last week’s data didn’t bode well for the Federal Reserve who have cut rates twice already this year to “sustain the expansion” and mitigate the impacts of trade tensions on the economy. The probability of a rate cut priced into Overnight Index Swaps has jumped from 38.8% pre-ISM data to 83.2% prior to the NFP release on Friday.
At the end of the week, expectations of a rate cut sat almost twice as high at around 75%. Events this week are important for USD investors, but are unlikely to reverse the damage already done.
Potentially, the FOMC meeting minutes released on Wednesday could confirm the markets view of a rate cut at the end of the month. That is if the scenario set out by the 7 dissenting members who opted for lower rates has played out since September 18th.
The likeliest scenario, however, is that last week’s data made the Feds prior judgement of the US economy look dated. The only potential source of alleviation for both the Fed and the USD is marked progress in US-China trade negotiations.
Trade talks are set to resume in Washington on October 10-11th, but a delay in the 5% tariff increase scheduled for October 15th looks like it will be too little too late to stop the USD decline and heightening expectations for more rate cuts. The conditions are prime for conducive trade talks, however.
Both economies are beginning to show signs of fatigue after digging deeper trenches since June 2018
With a flagging economy, the pressure of impeachment and an election just around the corner, it may be time for President Trump to retreat on intellectual property theft and follow through on his recent announcement that a trade deal was on the horizon.
Given the track history of the US-China trade war though, things may have to get worse before they get better.
We have factored all of the above into our Q4 forecasts and in turn, we have revised down our DXY Q4 call to 97.00.
Author: Simon Harvey, Market Analyst at Monex Europe