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US: ISM May Skirt Contraction, But it Changes Nothing for the Fed

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It is no secret that the global recovery has slowed in recent months but reports of weaker manufacturing activity on both sides of the Atlantic this morning was a harsh reminder for anyone focusing too hard on pre-QE3 trades. Even though the ISM manufacturing index in the U.S. fell less expected, it doesn't remove the need for more stimulus. The Federal Reserve will be relieved to see that the manufacturing sector is still growing but this doesn't change anything because the U.S. is a service based economy and the problem is in the labor market. The stronger ISM report will only put greater emphasis on Friday's jobs number. The sustainability of any risk rally hinges upon a strong payrolls report. Investors have bid up the dollar following ISM but the gains should be limited because of the potential disappointment in NFPs. What is important to remember is that at the end of the day, global growth is slowing and this is why normalization of easy monetary policy around the world has come to a screeching halt. Any rally in the dollar will be capped by the prospect of another round of stimulus.

According to this morning's ISM manufacturing report, industrial activity expanded for the 25th consecutive month. With activity in the Chicago, Philadelphia, NY and Dallas regions slowing materially, the fear going into the number was that manufacturing activity across the nation would contract for the first time in more than 2 years. To the relief of the Federal Reserve, activity continued to expand, albeit at its slowest pace since 2009. The details of the report was far less encouraging than the headline number. The employment component of the report fell from 53.5 to 51.8, the prices paid component dropped from 59 to 55 while production contracted for the first time since June 2009. Improvements were seen in inventories, imports and the backlog of orders. The dollar also benefitted from other pieces of positive news. Jobless claims fell 12k for the week ending August 27th. Although claims remain above the key 400k mark, the decline bodes well for payrolls. Investors were also encouraged by the initial reports from retailers that showed spending increasing despite high unemployment, weaker confidence and the threat of a Hurricane. This is of course is in large part due to back to school shopping, which is the most important period for retailers next to the holiday shopping season.

Unfortunately slower manufacturing activity is not unique to the U.S. economy. Manufacturing activity in the U.K., Germany, France and Switzerland also slowed in the month of August. In fact, in the U.K. and the Eurozone as a whole, manufacturing activity slipped deeper into contractionary territory. China reported only a marginal improvement in manufacturing activity but with the index hovering slightly above the 50 boom/bust mark, whether the sector is expanding or contracting depends on which measure is used. According to government's official measure, the manufacturing sector is still growing but HSBC's manufacturing PMI index suggests otherwise. The euro has performed the worst because the weak Italian bond auction was followed by an equally disappointing Spanish bond auction indicating that European governments are having a very tough time attracting investors.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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