JP’s Journal: Summer doldrums

Last week’s data was reassuring, indicating that economic activity is not poised to stumble. In the US, the composite Purchasing Managers' Index (PMI) came in at 54.1 and is consistent with a decent pace of growth.

There remains a split between manufacturing and services; the former continues to lag, with the PMI below 50, but the latter recorded an improvement. The euro area PMIs were at a three-month high, led by France and attributed to the Olympics. There were improvements in both the services and manufacturing output indicators although new orders remained below 50 and business optimism fell. Germany continued to disappoint with indicators suggesting a contracting economy.

The UK continued to surprise on the upside with better PMIs for output and the new orders. Business optimism remained relatively upbeat and there was a pick-up in the employment PMI. Helpfully, there was also a fall in both input and output price PMIs. Together with the latest BRC Shop Price index, which showed a year-on-year fall, the inflation outlook seems to be improving.

Whilst there was no hint of panic, with the equity market volatility a distant three-week memory, the message was that a cut was imminent reflecting more confidence in the inflation trends

On the communication front, US Federal Reserve Chair Jerome Powell’s speech at Jackson Hole was consistent with a first rate cut in September. Whilst there was no hint of panic, with the equity market volatility a distant three-week memory, the message was that a cut was imminent reflecting more confidence in the inflation trends. Interestingly, references to the labour market indicated that cuts were not dependent on a further cooling. Overall, the tone suggests a 25 basis points reduction in rates next month and whilst a larger cut cannot be ruled out the data and market conditions do not seem to merit such a move.

Bond markets were quiet with yields broadly unchanged. The US curve is pricing about six 25bps cuts over the next six months. This seems to be too much – although it should be recognised that there is a tendency to underplay the extent of cuts once they start. Unless there is a much more significant slowdown than the data is currently suggesting there is scope for disappointment, and is the reason we have cut back duration in our government portfolios. Credit markets had a similar, end of summer feel, with little issuance in sterling credit. Spreads were unchanged and there was little newsflow.

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