Afternoon analysis 01.09.2015

Surprisingly weak ISM reading from the US manufacturing. The fixed income market believes in Fed comments? Unemployment approaches a record low level according to the Eurostat.

Weak ISM reading

After 16.00 CET the ISM manufacturing index was published from the US. It is one of the most important leading indicators for the American economy. The reading was much lower than expected. It dropped to 51.1 points whereas estimates were around 52.5 points.

The weakness was broad based. The production subindex slid by 4.8 points to 51.7 and employment decreased to 51.2 from 52.7. Additionally, export dived further into negative territory and currently it is only 47.5 points. Number 50 separates contraction from expansion. The overall reading is the weakest in two years which may be regarded as a message for the Fed to delay the interest rate hike.

The fixed income market believes in hikes

In the recent weeks we have observed a strong positive correlation between the US bonds yields, stocks and the dollar. In a high risk averse environment all the mentioned assets were losing value.

The tendency was disturbed especially when we look at the current level of S&P 500 and at what yields 2-year bonds are traded. In significant risk averse trade the S&P 500 dropped to around 1930 points last Monday while 2-year yields were only 60 bps.

At that time the dollar was worth only 87 euro cents (EUR/USD – 1.15). Currently, we see that the slide towards 1930 on the S&P 500 2-year yields stays above 70 bps. This fact keeps the dollar around 89 euro cents (EUR/USD – 1.1240).

Dollar value, 2-year bond yields and S&P 500 index

• Source: Bloomberg, own calculations.
• Green line – USD/EUR pair – the quotes are reversed to show more clearly the dollar behaviour. White line – 2 year bonds in percentage points. Yellow line – S&P 500 contract.

Lower sensitivity of the bond market to the “risk off” sentiment may suggest that the fixed income traders have started to believe in the suggestions from the Federal Reserve members that there is no reason to move the first interest rate hike beyond 2015. It also affects the EUR/USD trading which does not rise despite the S&P 500 drop. The correlation between the equity index, bonds and the dollar starts to decrease. It may also mean that the EUR/USD might be more prone to downside risk because it may resist to rise in the overall market turmoil but can speed up the slide.

The zloty is slightly lower

The local currency hasn't reacted to the weak data from Polish manufacturing. But if the US market finishes the day on more than a 3-percent slide then the EUR/PLN may rise towards a 4.25 level at the end of trading in the States.

Today, we presented many negative messages, but it is worth looking at one key indicator. According to the Eurostat, unemployment in Poland dropped again and the seasonally adjusted level is 7.6%. It means that it is approaching levels just after the global economy picked in 2008.

Unemployment level in Poland since 1997

• Source: Bloomberg, Eurostat
• Unemployment level in Poland.

The market does not really care much about unemployment because it is not the leading indicator to what is even well proved in its behaviour before the slump in 2008/2009. A further unemployment decrease is expected which should be positive for wages and future economic expansion.