Monday, 4 August 2014

Diverging PMIs lead the way for diverging policy

PMI data in the US and China improved in July, while Japan and Europe remain too close to stall speed for anyone's liking.

The diverging fortunes of the PMIs sets the scene for diverging paths for policymakers over the next 12 months. The Fed will be looking to take its foot of the accelerator, China to reconsider the real vs. financial growth tradeoffs, while Europe and Japan will continue to try to stoke economic activity.

The strong US ISM index gels nicely with most of the other indicators out of the US at present, which have been showing better momentum. This is setting the Fed on a path to raising rates next year.

The latest China PMI data also confirms stabilisation in activity following efforts of policymakers to stem the downside risks emerging at the start of year.

This is, however, coming at the expense of failing to deal with the mounting financial risks, with credit growth bouncing back very strongly in the past few months.

This is not sustainable and will either end with a big market induced crash or a more managed period of weakness due to policy restraint.  It seems likely that policy makers will step in to cool things down, perhaps heading into the end of this year.

The ECB still looks like it has some work to do given the pace of improvement in activity remains slow and the downside risks to inflation worrisome.  The failure of the Euro to meaningfully weaken is a particular problem for large French manufacturers, where PMI data points to declining activity.

Global industrial production should hold up reasonably well given the strength in the two biggest countries in China and the US.

But the diverging fortunes will have important implications for financial markets and currencies.