Dissenting macro data call for caution

 

As the summer goes on, the market stabilisation seen in early July has translated into assets pricing a better balance between recession fears and hopes of a disinflationary soft-landing. Placing the right weight on these potential outcomes for the future of the world economy is the only question that portfolio managers need to consider when preparing their allocation for August and, more importantly, for the dreadful month of September. We think there is room for opposing views in this recession / soft landing debate and the macro data clearly agree with that multiplicity of admissible points of view. The US situation in this respect is naturally of paramount importance, and there job creations are clearly contradicting industrial leading surveys such as the ISM. The former paints a picture of a still flourishing US economy while the latter points to the economy entering into a recession soon. Which of the two stands a better chance of being right? Has this happened in the past? These are questions we are looking at in our bid to find answers.

Today, there is dissent within economic data – especially within the US. The US economy created just under 400,000 jobs in June, a very large number by historical standards. Since 1950, the US economy has created around 120,000 jobs per year, with an even higher median (165K). Over the 2010-2019 decade (excluding the abnormal 2020-2021 pandemic period), this average rose to almost 190,000. The most recent number was 372,000, nearly twice as high as the past decade’s average. Impressive. From that perspective, the US economy is roaring. At the same time, the manufacturing ISM survey is regarded as a leading indicator for the US economy. Its “new orders” sub-component is an even more robust indication of the health of the US economy than the wider survey itself. This data point has survived our nowcasting tests and is part of our US growth nowcasting indicator shown below. The most recent data point published at the beginning of July fell below the 50 threshold – dropping from 55.1 to 49.1 – which usually indicates a recession will occur in a matter of months. This happened in December 2007 (remarkably marking the entry point for the 2008 recession, as noted by the National Bureau of Economic Research) and in September 2000. Conversely, a move above 50 is indicative of a recovery – as happened in May 2009 for instance. How can one key data point – job creation – be indicative of a robust macro backdrop when another – the manufacturing ISM survey – is indicative of near-entry into a recession?

 

Chart 1: US non-farm Payrolls vs. ISM new orders-based estimate

Source: Bloomberg, LOIM

 

Chart 1 compares both data series, once rescaled. To do this rescaling, we have transformed the new-orders component of the manufacturing ISM survey into job creation numbers, based on a regression. As clearly shown on the chart, both time series have historically evolved in concert, marking macro downturns through their joint collapse. But not this time! The June payroll numbers of 372,000 do not compare well with the ISM-implied number of -160,000. According to the new orders time series, the US economy should have destroyed jobs last month, not created jobs. This highlights the difficulty of the puzzle investors are facing today: which of these two indicators should we use to determine our portfolio allocations? The jobs report recommends adding equities while the ISM report points to a lower equities exposure? It may be hard to see, but the data actually hide three interesting bits of information:

• First, the still roaring job market could be more of a lagging indication in comparison to the ISM numbers which have already digested the impact of the post-covid period. The service sector – which is currently the #1 source of job creation – is still finishing its normalisation and could explain this anomaly. Anecdotally, the June job reports shows a decline in the percentage of job creating sectors, dropping from around 90% to 70%.
• Second, this is not the first time both indicators have disagreed historically, it is actually the second time it has occurred during the 1950-2022 period. The first time was between August 2011 and January 2012 and the gap between both data sets can be attributed to the European recession during that period. Manufacturing surveys declined (as well as commodities) as European imports slowed, but the US job market experienced a limited reaction to the European-specific recession. Today’s situation seems comparable.
• Finally, Chart 2 shows the average level of job creation that can be expected over the next six months if the ISM survey remains below 50. This picture is far from rosy: if the ISM survey remains below 50 for six  months, a monthly level of job destruction around 146K would not be surprising. If it remains that way for 12 months, regressions show this average could reach 163K.

 

Chart 2. Expected job creations if the new order component ISM remains below for 1 to 12 months

Source: Bloomberg, LOIM

 

As our readers should be aware by now, we are inclined to place greater emphasis on the ISM survey, rather than on the job market report at present. This conviction is supported by our nowcasting indicators: two data points are far from being enough to judge the macro backdrop.  During July, our indicators have shown a remarkably uniform downtrend that we have not seen before. The jobs report is therefore more of an exception than a rule. From that perspective, the next phase of the cycle will, in our opinion, see more downs than ups: let’s be prepared.

Simply put, divergent macro indicators can explain a major part of markets’ recent hesitation. Analysing the data suggests the macro environment looks set for a deterioration, rather than an improvement, especially in Europe.

 

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Macro/Nowcasting Corner

The most recent evolution of our proprietary nowcasting indicators for world growth, world inflation surprises and world monetary policy surprises are designed to keep track of the latest macro drivers making markets tick. Along with it, we wrap up the macro news of the week.

Our nowcasting indicators currently point to:

•    Worldwide growth is clearly declining. The US and Eurozone are showing signs of decelerating growth momentum. In China, growth momentum remains subdued, but more than 50% of data are now improving.
•    Inflation surprises will remain positive for the Eurozone but are declining elsewhere.
•    Monetary policy is set to remain on the hawkish side: central bankers are likely to be more hawkish than expected.
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World Growth Nowcaster: Long-Term (left) and Recent Evolution (right)

 

World Inflation Nowcaster: Long-Term (left) and Recent Evolution (right)

 

World Monetary Policy Nowcaster: Long-Term (left) and Recent Evolution (right)

Reading note: LOIM’s nowcasting indicator gather economic indicators in a point-in-time manner in order to measure the likelihood of a given macro risk – growth, inflation surprises and monetary policy surprises. The Nowcaster varies between 0% (low growth, low inflation surprises and dovish monetary policy) and 100% (the high growth, high inflation surprises and hawkish monetary policy).