Aug U.S. ISM manufacturing index expected to edge to a new 1-1/3 year high
U.S. inflation expectations reach new 8-month high on Fed policy and commodity pricesAug U.S. ISM manufacturing index expected to edge to a new 1-1/3 year high — The consensus is for today’s Aug ISM manufacturing index to show a small +0.3 point increase to 54.5, adding to July’s +1.6 point increase to 54.2.
Expectations for an increase in today’s ISM index are supported by the recent news that Markit’s U.S. manufacturing PMI in early August rose by +2.7 points to 53.6. That index today is expected to be unrevised in the final-Aug report from the preliminary-August figure of 53.6.
The ISM manufacturing index plunged by a total of -9.4 points in Feb-April to an 11-year low of 41.5 in April due to the pandemic. However, the index in the following three months of May-July rose by a total of +12.7 points to July’s 1-1/3 year high of 54.2, moving above the pre-pandemic level of 50.9 seen in January.
While manufacturing confidence has improved, the U.S. manufacturing sector is not yet out of the woods. The U.S. manufacturing sector was in a recession before the pandemic due to weak global economic growth and trade tensions. The pandemic then decimated the U.S. manufacturing sector when non-essential businesses were forced to shut down, domestic and overseas demand plunged, and component shortages caused production delays. The U.S. manufacturing sector has yet to prove that it is in a sustainable recovery.
The European manufacturing sector is in a similar position, having already been in a weak position before it was hit hard by the pandemic. The Markit Eurozone manufacturing PMI plunged to a 6-year low of 33.4 in April but has since recovered to 50.7, which is mildly above the expansion-contraction level of 50. The consensus is for today’s final-Aug Eurozone manufacturing PMI to be unrevised from the preliminary-Aug figure of 51.7, which would leave the index down slightly by -0.1 point from July.
Meanwhile, China’s economy is in better shape than either the U.S. or Europe since China has recently managed to keep its new Covid infection rates very low so far, thus reducing business disruptions. China’s national manufacturing PMI plunged to 35.7 in February but has since recovered to 51.0 in August. China’s new-orders manufacturing PMI sub-index was fairly strong at 52.0 in August, but export orders are lagging with the August export-order PMI sub-index at only 49.1.
U.S. inflation expectations reach new 8-month high on Fed policy and commodity prices — The 10-year breakeven inflation expectations rate on Monday rallied to a new 8-month high and closed the day up +2.7 bp at 1.805%. The breakeven rate is very close to challenging the 15-month high of 1.818% posted in January before the pandemic decimated the U.S. economy.
The breakeven rate plunged to an 11-year low of 0.47% during the pandemic crisis in March, but has moved sharply higher and is now even higher than it was before the pandemic.
The sharp rise in the breakeven rate has been driven by inflation expectations caused by the Fed’s extraordinarily easy monetary policy. The Fed is expected to keep its funds rate pegged near zero for at least the next several years. Also, there is no end in sight for the Fed’s $120 billion per month QE program.
The rise in the breakeven rate has also been driven in the past several sessions by Fed Chair Powell’s announcement last week that the Fed is now explicitly following a flexible inflation-averaging target. That means that the Fed plans to push inflation above 2%, after periods of below-2% inflation, so that inflation averages closer to 2% over the long-run. Since the Fed adopted its 2% target in 2012, the Fed has persistently undershot its target as seen by the fact that the core PCE deflator has averaged only +1.6% since 2012.
Inflation expectations are also being pushed higher by the steady rise in commodity prices seen since April. The Refinitiv Equal Weight Commodity Index (CCI) plunged to a 15-year low in March, but has since rallied back to the pre-pandemic levels seen in January. The CCI index on Monday rallied to a 6-month high and closed the day +0.71%.
Commodity prices have been driven higher by the sharp sell-off in the dollar index to a 2-1/4 year low and by the Fed’s massive liquidity injections into the financial system. Commodity prices are also being driven higher by the economic recovery in China, which means that commodity demand is reviving.
However, the nearby chart shows that there is a big variation in how commodity prices are faring this year. Gold (+29% year-to-date) and silver (+59%) are the big winners, seeing support from the Fed’s monetary policy and the massive debt-fueled stimulus programs being pursued by most governments in North America and Europe. Natural gas (+12%), copper (+18%), and nickel (+9%) are also winners.
On the negative side, the petroleum sector is in the worst shape with a year-to-date loss of -30% in crude oil, -40% in heating oil, and -29% in gasoline. Crude oil prices have partially recovered on the expanded OPEC+ production cut, but remain on the defensive due to weak global fuel demand and doubts about how long OPEC+ members will stick to their production cuts.
The ag markets are mostly seeing year-to-date losses due to weak demand and ongoing trade tensions. China is far behind on its purchasing requirements for U.S. ag and energy products under the phase-one trade deal.