Headlines from the trade and geo-political fronts have dictated market direction lately, but that could shift this week shift with economic releases coming to the fore. Yesterday’s ISM Manufacturing numbers sent a shudder through markets and helped push Treasury yields lower yet again. We discuss the ISM numbers in more detail below but coupled the upcoming ISM Non-Manufacturing (services) report due tomorrow and the August jobs report on Friday any additional signs that global slowing and trade uncertainties are increasing the headwinds on the domestic economy will only add to the Treasury rally. A modest risk-on tone has developed this morning with a little good news on the geo-political front (see Hong Kong and UK), and that has 10-year Treasury yields backing all the way to 1.49% and 30-year yields to 1.99% (sarcasm alert). With a Fed meeting in two weeks, and an expected 25bps rate cut, it’s not stopping the long-end rally that is equal parts grabbing-foryield and increasing conviction that a lower fed funds rate will be insufficient medicine to stem the gathering global slowdown issues. If tomorrow’s ISM Non-Manufacturing report exhibits some of the same weakness as the manufacturing numbers expect continued moves lower in yield after this tepid risk-on mood passes.
If the Fed is looking for signs that the global slowdown and trade war uncertainties are washing up on our shores they found plenty of evidence in the latest ISM Manufacturing Index. The August read came in at 49.1 versus 51.2 in July and was well below the 51.2 pre-release expectation. The 49.1 print was the first below the 50 dividing line that separates an expanding sector from a contracting one since 2016. The report fed the ongoing bond rally as investors see evidence that global woes and trade uncertainties are impacting manufacturing orders and confidence.
Details within the report were just as gloomy as the headline print. New orders dropped to just 47.2 versus 50.8 in July and missing the 50.5 forecast. That result tied with 2012 as the lowest since early-2009, when the Great Recession was at its most profound. Prices paid also disappointed at 46.0 versus 46.8 anticipated, but that was at least better than the 45.1 in July.
Also concerning were inventories that ticked higher which is typically a harbinger of slowing activity. The increased inventory left the important New Orders vs. Inventories spread at -2.7 points, the weakest since 2012 (we discuss that metric in more detail below). Employment was also softer at 47.4 versus 51.7 in July. If the results didn’t speak loudly enough that trade uncertainties are having an impact on manufacturers, comments from survey members certainly added to the chorus, namely "Comments from the panel reflect a notable decrease in business confidence." That decrease in confidence was felt in the drop in new export orders which fell -4.8 points to 43.3, the lowest reading since April 2009 and the largest one-month drop since 2012.
The ISM Manufacturing Index has been weaker versus its Non-Manufacturing sibling for quite some time but the drop below the 50 dividing line for the first time since 2016 certainly adds to the concerns that have been manifested in lower bond yields. The ISM Non-Manufacturing Index for August is due tomorrow with a slight uptick to 54.0 expected versus 53.7 in July. Given the manufacturing index’s disappointing print, investors will be looking for any signs that the manufacturing weakness is bleeding into the much broader services sector.
While the monthly employment reports get all the attention from the financial press the more forward looking ISM surveys provide a timelier tell on the latest economic activity than the more lagging jobs reports, and if the disappointing manufacturing read is repeated with the services numbers on Thursday, even a strong jobs report on Friday is not likely to shift the outlook in the bond market. For its part the employment report is expected to post decent numbers with headline job gains of 160,000 expected. It should be noted that even if that result is realized, it will still reflect a slowing in momentum as the last twelve months have averaged 187,000 new jobs.
As we noted last week the consumer continues to spend, seemingly unfazed by stock market volatility, geo-political concerns, and moderating growth prospects, and as long as that continues the economy should post decent GDP results. However, the fear is that the consumer may retrench if there are more signs that global slowing is reaching our shores. If the jobs numbers start to reflect a more pronounced slowing in hiring you can expect consumer confidence to take a hit and with business confidence and investment in retreat, a stalling in GDP is possible if the consumer steps back. It’s that possibility that has helped drive bond yields lower and could continue to do so if the signs of weakness spread.
ISM New Orders — Inventories Takes a Dip
While the ISM Manufacturing Report for August was a disappointment many of the details within the report were equally as troubling. The graph illustrates the spread between ISM 'New Orders' minus 'Inventories'. While not definitive on a single month’s print there is a correlation between a negative spread and recession (shown in the red shaded areas). If inventories are building faster than new orders it indicates a likely slowing in future activity until excess inventories are worked off. The trade war and issues related to cross-boarder flows have complicated this indicator but the 2019 trend lower and August’s –2.7 point spread could portend recession if the spread persists for another month or two.
Agency Indications — FNMA / FHLMC Callable Rates
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