Will the Fed message soften at Jackson Hole?
The preliminary August PMI Manufacturing and Services figures were released yesterday for France, Germany, the Eurozone, the UK and the US. Numbers were poor across the board and brought about some deviation in recent trends.
Starting with Manufacturing, the index fell by 2 and 2.5 points in the US and the UK respectively, both underperforming consensus. At 47.0, the US index is revisiting recent lows whereas in the UK, at 42.5, the index is at a 39-month low. Although France and Germany outperformed consensus, at 46.4 and 39.1 respectively, there is very little to celebrate in our view. With only a few exceptions, global manufacturing is in contraction mode. The detail in the reports speak of lower New Orders across the board, which does not bode well for the next few months. The only positive note we can extract from the releases is that European Manufacturing PMIs seem to be finding a floor at low levels, but without a doubt we need a couple more reports to more convincingly state the aforementioned.
The Services sector on the other hand has held up better than the Manufacturing sector, with the recovery here gaining traction a little bit later due to the movement restrictions post Covid, which has resulted in Manufacturing seeing an end to the positive trends earlier than the Services sector. In the Eurozone, August saw the Services PMI falling below the 50.0 threshold that separates an expansion from a contraction for the first time this year. In the US the sector remains in expansionary territory at 51.0, but there was a significant gap to the 52.2 figure the market expected.
After GDP growth surprised on the upside in Q2 for core Europe, the UK and the US, the start of Q3 has left a lot to be desired. We have long advocated for a softish landing scenario for the global economy; this is one where there is a mild recession, with growth just below the zero mark, for a couple of quarters, sees default rates moving up towards long term averages alongside an unemployment rate that increases but remains well below the norm for a recessionary environment. Over the last few weeks growth projections have been revised upwards, in particular in the US, to a point where we think they start to look a tad too optimistic.
In our view, the combination of Q2 data being stronger than expected, the earnings season not delivering surprises regarding regional banks in the US and the expectation we are approaching the end of the hiking cycle, while the labour market remains strong, means that the probability of a hard landing has receded. This is not the same as saying that there will be a “no landing” scenario. The PMI data is a reminder that the hiking cycle only started 18 months ago and there are lags that are yet to be felt in the real economy. In this context, we reiterate our view that 10Y Treasuries (and longer) are an inexpensive hedge given current conditions. We also reiterate our view that given where absolute yields and spreads are at the moment, there are parts of the credit market that we think look particularly good value, with financials and European CLOs standing out.