The hope for a recovery in the last quarter of 2019 disappeared with today’s non-manufacturing ISM report. Investors can no longer fool themselves into thinking that the US can escape the global slowdown. After learning that manufacturing activity contracted at its fastest pace in 10 years, ISM reported the weakest service sector activity index since 2016. American businesses are feeling the pain of the slowdown of the economy and the trade war. Unfortunately even with central banks easing monetary policy across the globe, the slowdown will deepen so investors are looking beyond Friday’s non-farm payrolls report to the FOMC meeting later this month and the potential for action.
A number as weak as today’s ISM should drive the US dollar, Treasury yields and stocks lower across a board. We got a glimpse of that on Tuesday and Wednesday when stocks fell more than 800 points following disappointments in ADPWealth Strength IndexAAPL is Extremely Up and trending Up and manufacturing data. The US dollar also dropped across but we saw more restrained selling Thursday even though non-manufacturing ISM is a more significant release. All of this tells us that investors are bracing for a weak jobs number and investors are all but certain that the Fed will be forced to lower interest rates again this year.
Fed fund futures are pricing in 87% chance of a cut on October 30th and a 96% chance of a cut by December 11th. This outlook is far more aggressive than most policymakers may be prepared for. When the central bank cut rates in September, 2 members voted for no change and the majority did not expect additional easing this year. The question now is whether this month’s reports will change so many views. While manufacturing was slowing for most of the year, services perked up enough in August for Fed Chairman Powell to say that he expects the economy to remain strong. Investors on the other hand sent the US dollar tumbling lower because they believe that these reports will force the central bank to ease for the third time this year.
Dollar bears will be looking for validation from non-farm payrolls and while economists predict slightly higher job growth, investors are bracing for another ugly report. The arguments favor a weak release. Hiring in the service sector was at a standstill while the manufacturing sector shed jobs at the fastest pace in 5 years according to ISM. ADPWealth Strength IndexAAPL is Extremely Up and trending Up also reported weaker private payroll additions explaining the collapse in the Conference Board’s consumer sentiment index. The drop in layoffs reported by Challenger and the improvement in the UMich survey won’t be enough to offset the deterioration in other reports. Wage growth is also expected to slow and we would not be surprised if the unemployment rate ticked higher.
Positioning for a weak jobs report could pay off but given the volatility this report typically induces, exposure should be limited. If payroll growth is less than 140K and average hourly earnings growth slows to 0.2%, we could see a more durable decline in the dollar that takes USDJPY below 106. However if there’s anything in the jobs number that could casts doubt on another round of easing, the dollar will squeeze sharply higher. Stocks on the other hand could react positively to a positive and negative number if investors immediately think that additional easing will be necessary.
Leading Indicators for Non-Farm Payrolls
Arguments for Stronger Payrolls
- University of Michigan reports improvement in confidence
- Continuing Claims Fall
- Challenger Reports 24.8% Drop in Layoffs
Arguments for Weaker Payrolls
- Employment Component of ISM Non-Manufacturing Index Drops to 5 year low
- ADPWealth Strength IndexAAPL is Extremely Up and trending Up Employment Change Drops to 135K from 157K
- Consumer Confidence Index Declines the Most in 9 Months
- Employment Component of ISM Manufacturing Index Drops to 3 year low
- Lower 4 Week Average Jobless Claims