Currently, data which suggests the US economy is picking up momentum (as opposed to losing it) is bad news.
Yes, recession fears are rampant, which means evidence of a rapid downshift wouldn’t be welcome either, but the Fed is very keen on demonstrating fortitude in the inflation fight. Between the new dot plot and accompanying economic projections, it’s obvious the Committee intends to engineer a material slowdown. Jerome Powell is clear on that, even if he feels bad about it.
The problem for fragile markets is that evidence of economic resilience in the US emboldens the Fed, which in turn means higher US real rates and a stronger dollar. That’s bearish for risk assets, and it’s very bad news for emerging markets. Everyone can recite that narrative.
What I’ve tried to make clear over the past two weeks, though, is that in 2022, it’s not just EMs and risk assets that are at risk of imploding in the face of a determined Fed. On Thursday evening, I suggested everything might be about to “come apart.” Around 12 hours later, the pound sank to the lowest since 1985 and gilts plunged as markets recoiled at Liz Truss’s “radical” growth plan for the UK. Preliminary PMI data for Europe suggested Germany is headed for recession, and the euro dropped sharply along with European equities.
By contrast, S&P Global’s flash PMIs for the US topped expectations. At 49.2, the services gauge printed in contraction territory again, but still managed a rousing rebound from last month’s abysmal print (figure below) and beat the highest estimate from 19 economists. It was the best reading since June.
The manufacturing gauge was also ahead of estimates. A measure of factory employment rose to the highest since March.
Recall that August’s services sector PMI from S&P Global stood in stark contrast to a more upbeat read on ISM’s gauge. Friday’s flash print on the former suggests the disparity resolving in favor of ISM, although one imagines the two may find some “compromise” via a lower ISM reading for September.
Of course, 49.3 (the preliminary read on S&P Global’s composite gauge for the US in September) isn’t exactly ebullient. In fact, we just witnessed “the weakest quarter for the economy since the global financial crisis if the pandemic lockdowns of early-2020 are excluded,” as Chris Williamson, Chief Business Economist at S&P Global Market Intelligence, noted on Friday. But moderating rates of contraction versus August, particularly in services, and the return of order book growth, should “allay some concerns about the depth of the current downturn,” Williamson went on to say, adding that “there was also better news on inflation, with supplier shortages easing to the lowest since October 2020.”
All of that’s good news. For the US. And that’s bad news for everyone else, including, ironically, US investors. Inflation is only moderating from extraordinarily high levels, and notwithstanding the likelihood that supply-side factors will ease further going forward, the recovery, especially in the services sector, suggests core inflation won’t soon fall enough to warrant any kind of rethink at the Fed.
As the pound sank and the euro dropped further below parity, the dollar surged again Friday to another fresh two-decade high (figure below).
This was among the best weeks in a decade for the greenback.
Do note: The damage isn’t just an “over there” problem. It’s a big headwind for US corporate profits. The FX drag was a hot topic during Q2 reporting season, and there’s every reason to believe it’ll feature prominently this quarter too.
In a new note, David Rosenberg called dollar strength a “wrecking ball.” Earnings, he said, are its “next victim.”
According to Rosenberg, the dollar’s influence on S&P 500 revenues is the most pronounced at nine months. That means “Q3 will really be the first time that the dollar’s rally from earlier this year will weigh on results,” he cautioned.