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In the latest issue of Market Week in Review, Shailesh Kshatriya, Director of Investment Strategies, and Greg Coffey, Director of Institutional Investment Solutions, discussed the latest August Purchasing Managers’ Index (PMI) data. They also chatted about the recent Federal Reserve (Fed) rhetoric and its impact on the markets.
Global PMI readings point to an ongoing economic slowdown
Coffey opened the conversation by noting that several preliminary August PMI readings were recently released around the world, including in the US, UK and the Eurozone. Kshatriya said these surveys taken together point to a broad slowdown in global economic conditions in both manufacturing and services.
Starting with the US, he said the S&P global composite PMI fell to 45.0 in August from a reading of 47.7 in July. A reading above 50 indicates expansionary conditions, while a reading below 50 indicates contractionary conditions, Kshatriya explained, noting that August marked the second straight month that the composite PMI was in contractionary territory.
So what’s behind the drop? Kshatriya said this was largely driven by a sharp decline on the services side, with the S&P Global Services PMI plummeting from above 50 in June to just 44.1 in August. “This weakness in the services sector is somewhat surprising given that consumption has held up well and most US households are sitting on about $2 trillion in excess savings,” he noted. With consumer spending driving the US economy, Kshatriya said this development needs to be closely monitored.
PMI surveys from other regions of the world were also pointing to a slowdown in growth, he said, with the UK’s composite PMI for August slipping to 50.9 — just slightly above the expansion-contraction line. In addition, the UK manufacturing PMI fell into contractionary territory, falling to 46.0 in August from a level of 52.1 in July, Kshatriya noted. A similar situation was playing out in Europe, he added, with the euro-zone composite PMI falling to 49.2, while both Australia and Japan’s respective composite PMI indices were also below 50.
Kshatriya explained that PMI surveys are carefully monitored as they are seen as leading indicators of upcoming economic conditions and in this case the latest releases confirm that a slowdown in growth is underway. “Ultimately, the numbers show that global economic momentum is slowing as central banks continue to hike interest rates. It also suggests that banks are, in some ways, achieving the intended impact of tighter funding conditions – by dampening inflation, by slowing the economy,” he explained.
Fed officials stress ongoing fight against inflation
Shifting to the Fed topic, Kshatriya noted that Chairman Jerome Powell’s Aug. 26 speech at the Jackson Hole, Wyoming Economic Symposium comes at a critical time, particularly given the rally in markets since mid-June. Since Aug. 25, the S&P 500 Index® is up nearly 15% from its mid-June lows, he said, with the benchmark 10-year Treasury bond yield falling to 3.02% since it hit 14 June peaked at around 3.5%.
“The broad stock rally over the summer and the drop in yields seemed at odds with the direction the economy is taking – especially given the Fed’s apparent intent to tighten financial conditions to curb inflation. This may be because markets viewed the July 26-27 central bank meeting as slightly dovish and may have been hasty in pricing in rate cuts amid rising recession risks,” Kshatriya noted.
Interestingly, he said that since the late July meeting, speeches by various members of the Federal Open Market Committee (FOMC) have all been fairly synchronized, with one key message: that the Fed’s job is to bring inflation down, and that this requires a tighter one monetary policy. This rhetoric from the Fed appears to be having the intended effect, Kshatriya noted, as markets stabilized after a multi-week rally and the yield on the 10-year Treasury rose to around 3.0% after rising to around 2.6% in early August had fallen.
“However, keep in mind that it is late summer in North America – and trading volume tends to be lower at this time of year. I think we’ll get a better sense of the true market trend in September,” Kshatriya explained, adding that the Fed will still view inflation as public enemy number one.
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