Episode 15: FOMC minutes and US manufacturing

This is Before and After from Refinitiv. I'm your host, Johanna Botta. In today's Before section, we'll be looking at the U.S. Markit Manufacturing PMI as well as the German IFO. And in the After section, we'll be reporting on the FOMC minutes. 

Right now, it's a tale of two economies in the U.S. You have the services and small business economy, which seems to be going along quite nicely. And then you have the Manufacturing sector, which has yet to rebound in any meaningful way. It will be interesting to see if services strength will have rubbed off on manufacturing or vise versa. Also of significant interest in this report is whether the spread and fear of Coronavirus had deep impacts on U.S. Manufacturing, after numerous corporate reports of supply chain disruptions. This will be one of the first major indicators of the total impact in January at least. Let's look at what happened recently. 

Last month's Markit Manufacturing PMI came in at 51.9. Any reading above 50 indicates expansion, which is the minimum we want to see here. This month the estimate is for 51.5, still growing yet at a slower rate and flirting ever so dangerously with a decline in manufacturing. So what would a shock reading under 50 do at this point? Well, we've seen a stock market that rallies on bad news in all shapes and forms. So would this be any different? Has Apple's warning of Chinese manufacturing supply issues already shown up in U.S. Manufacturing PMI? If it has, the market has completely ignored a very real flashing red warnings, and so rapid repricing remains a risk. We all know about some high profile U.S. Manufacturers that are suffering, like Caterpillar, but some lesser known companies with large portions of the revenue based on Chinese expansion are also suffering. Take A.O. Smith, for example, who manufacture water heaters for both residential and commercial use. They depend on China for 35% of the revenue and it shows in the stock, which is already down 7% year to date, while the S&P 500 is up 4%. The stock is 39% off of its all time highs made in 2018, proof that not everyone is sharing in this relentless bull market. It's safe to say that a reading in the low 51 range or worse would see A.O. Smith test a 40 level that it's maintained a number of times since the beginning of 2019. But we'll have to keep an eye on that. 

Speaking of knock on Coronavirus impacts, we'll get more clues on the global economic impact in the form of German Business Climate IFO early next week. As one of Germany's largest economic think tanks, it is widely known for its monthly IFO Business Climate Index Reports for Germany. Germany narrowly avoided a recession in 2019 as the economy stabilized in the fourth quarter after a sharp drop in Q3. But perhaps hopes for a V-shaped recovery might be too optimistic. Germany is dependent on exporting to China all things industrial. Today, some 5,200 German companies operate in China, and about 900,000 jobs in Germany depend on exports to China, according to the Association of German Chambers of Industry & Commerce. So in 2018, for the third consecutive year in a row, China was named Germany's most important trade partner with commerce between the two nations totaling about $226 billion, according to government figures. Some conservative estimates show that if the Chinese economy were to shrink by 1%, German growth would fall by 0.06%. So why is the DAX trading at an all time high and 20% higher than its lows from last August? It's the banks! Yes, the German banking sector has been kicked around for years, and maybe enough is enough. But in what ways would 0.06% of GDP disappearing be a bullish thing for the German banks? The weakest sectors of EWG this year are autos and Thyssenkrupp, the historic German steel company. It's truly a tale of two markets in Germany. The financials - which have priced in some sort of bottom in the German economy and the Industrials - which have yet to bottom out. 

So let's run through some scenarios. Option 1. The IFO Business Climate Index comes in very weak in the mid or low 90s. Last month it was weaker than expected, coming in 95.7 Versus the 97 expectation. Option 2: the DAX is truly a forward looking mechanism and the IFO rebounds to match the priceD IN optimism in German stocks, despite pressure from Chinese weakness. Option 3:  IFO is in a holding pattern and we see the same levels for another month. In the worst case, which would be the continued collapse of IFO, it's hard to see Germany's stocks continuing to outperform the rest of Europe. In fact, two of those three scenarios would be decent catalysts for profit taking and it's difficult to make the sector rotation argument either. The selling would probably be broad based. 

The Fed indicated in their minutes report that their current policy rates was ‘appropriate’ for some time longer. They cited risks from Coronavirus and a willingness to let inflation overshoot 2% to achieve longer term objectives and full employment. As is always the case with economic releases these days, especially ones where little action was expected, the market did little to react. Perhaps this fact is interesting, especially in the DXY, which was up 0.25 on the day up to 99.7, a recent high. The lack of clarity or resolve could pave the way for more dollar strength in the coming days. 

So there it is. U.S. Markit Manufacturing PMI and the German IFO and the Before, and FOMC minutes in the after. 

Refinitiv data throughout. 

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