US: Early rate hikes called off by weak data

Last week’s disappointing ISM manufacturing leading indicator and a weaker US employment report are putting question marks behind the strength of the US recovery in H2 2016.

The probability of US rate hikes this year has decreased. We continue to foresee the next hike in March 2017, but market expectations are set to intensify and the US dollar to profit.

Last week’s disappointing reading of the Institute for Supply Management’s (ISM) index for manufacturing and the rather weak US employment report should tip the US Federal Reserve over to a wait-and-see stance at the coming September meeting.

The ISM manufacturing index dropped to 49.4, i.e. below 50, which indicates a slight contraction ahead. Like all the purchasing managers’ indices, the ISM can be volatile and we would therefore refrain from reading too much into one number alone.

However, the weak number does remind us that the US manufacturing sector remains fragile and that we will likely see a bumpy and only weak recovery in the sector. This weakness in manufacturing was also mirrored in the August employment report, which revealed 24,000 jobs lost in the manufacturing sector.

Thanks to solid growth in the services and government sectors, overall there were still 151,000 jobs added to the US economy in the past month. This represents a respectable but slower pace than in the month before. But structurally, the labour market still has weak spots with a low participation rate and very subdued wage growth.

While the US manufacturing sector remains vulnerable, the more robust services sector continues to add jobs, but with a slowing trend. We see this as a reason for the US central bank to keep interest rates on hold for the next months, especially if signs of a renewed weakening in the manufacturing sector solidify.

Nevertheless, other parts of the US economy, especially private consumption, will likely remain strong enough for rate-hiking expectations to intensify. We expect the US dollar to profit most from that and have a bullish view on the greenback.

Susan Joho is economist at Julius Baer

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