The US Dollar is back into the lower half of the range that has contained it since March last year while financial market volatility is low and valuations “full”. These are conditions that should allow the Fed to make its next rate hike without too much cost. Unfortunately though, the recent run of data on the US economy has been surprisingly soft. Last night’s shock decline in the ISM Non-Manufacturing Index is the latest example.
The weak ISM Non-Manufacturing index is potentially significant. It covers business conditions in the services and construction industries that account for 90% of the US economy and has a good correlation to future GDP growth. While this month’s sharp drop may turn out to be a one off, there is other supporting evidence of recent economic softening such as the drop in the Manufacturing PMI.
Janet Yellen’s Fed has been consistently conservative about tightening monetary policy and given the recent run of soft US data it now seems that the next rate hike is likely to be in December at the earliest.
The likely delay in the Fed’s next interest hike diminishes the risk that the overall tightening cycle will be faster than markets currently expect. Not only are rates more likely to stay unchanged for the next few months but the chances are the Goldilocks scenario for equity markets will persist well into next year. This scenario implies an outlook for continued moderate economic growth accompanied by very low interest rates.
While US stocks rallied last night the impact of lower for longer US interest rates is clouded for some Australian stocks by the sharply higher Aussie Dollar. $A goes into today’s GDP data with strong upward momentum that could be fuelled if there is a beat on already solid expectations for 2nd quarter growth.