Is the global economy slowing down?
On the latest edition of Market Week in Review, Director of Investment Strategies, Shailesh Kshatriya, and Director of Institutional Investment Solutions, Greg Coffey, discussed recent purchasing managers' index (PMI) data from August. They also chatted about recent U.S. Federal Reserve (Fed) rhetoric and its impact on markets.
Global PMI readings indicate economic slowdown underway
Coffey opened the conversation by noting that several preliminary August PMI readings were recently released around the globe, including in the U.S., the UK and the eurozone. Kshatriya said that together, these surveys suggest a broad slowing in global economic conditions in both the manufacturing and services sectors.
Starting with the U.S., he said the S&P Global composite PMI fell from a reading of 47.7 in July to a reading of 45.0 in August. A reading above 50 points to expansionary conditions, while a reading below 50 suggests contractionary conditions, Kshatriya explained, noting that August marked the second month in a row that the composite PMI has been in contractionary territory.
So, what's behind the drop? Kshatriya said it's largely been driven by a sharp fall on the services side, with the S&P Global services PMI plunging from a reading above 50 in June to just 44.1 in August. "This weakness in the services sector is a bit surprising, since consumption has held up OK and most U.S. households are sitting on roughly $2 trillion in excess savings," he remarked. Given that consumer spending powers the U.S. economy, Kshatriya said this development bears close watching.
PMI surveys from other regions of the globe also indicated a slowdown in growth, he said, with the UK composite PMI for August slipping to a reading of 50.9 - only modestly above the line between expansion and contraction. What's more, the UK's manufacturing PMI fell into contractionary territory, dropping from a level of 52.1 in July to 46.0 in August, Kshatriya noted. A similar situation played out in Europe, he added, with the eurozone composite PMI dipping to 49.2, while respective composite PMI indexes from both Australia and Japan also logged sub-50 readings.
Kshatriya explained that PMI surveys are carefully monitored because they're seen as leading indicators of upcoming economic conditions, and that in this instance, the latest releases confirm that a slowdown in growth is underway. "Ultimately, the numbers show that economic momentum is slowing globally as central banks continue hiking rates. This also suggests that the banks are, in a sense, achieving the intended effects of tighter financial conditions - in that they're curbing inflation by slowing down the economy," he stated.
Fed officials stress ongoing fight against inflation
Shifting to the topic of the Fed, Kshatriya noted that Chair Jerome Powell's 26 August speech at the Jackson Hole, Wyoming, economic symposium comes at a critical time, especially due to the rally in markets since mid-June. As of 25 August, the S&P 500 Index® is up nearly 15% from its mid-June lows, he said, with the yield on the benchmark 10-year U.S. Treasury note down to 3.02% since peaking around 3.5% on 14 June.
"The overall summer rally in stocks and drop in yields has seemed at odds with the direction that the economy is heading - especially considering the Fed's obvious intention of tightening financial conditions to rein in inflation. This may be because markets judged the central bank's 26-27 July meeting as slightly dovish, and perhaps prematurely priced in rate cuts due to rising recession risks," Kshatriya observed.
Interestingly enough, he said that ever since the late-July meeting, speeches from a variety of Federal Open Market Committee (FOMC) members have all been pretty synchronised, with one key message: that the Fed's job is to bring down inflation, and that doing so requires tighter monetary policy. This rhetoric from the Fed appears to be having the intended effects, Kshatriya observed, with markets stabilising after rallying for several weeks, and the yield on the 10-year Treasury note rebounding to around 3.0% after dropping to roughly 2.6% in early August.
"Keep in mind, however, that it is late summer in North America - and trading volumes tend to be lighter around this time of year. I think we'll get a better sense of the real market trend come September," Kshatriya stated, adding that regardless, the Fed will continue to view inflation as public-enemy number one.