What goes down must go up

What goes down must go up! A day that began with a stronger than forecast increase in China’s purchasing managers index (PMI) and firm Australian Q2 GDP continued with a surprise jump in the August ISM manufacturing index. The ISM rose to 56.3 from 55.5 in July an outcome that contradicted most of the regional US manufacturing surveys. It was not all positive in terms of data, yesterday however, with a weaker UK manufacturing PMI and unexpected drop in the August US ADP employment report casting a shadow over markets.

Nonetheless, for a change the market decided to act on the good news, with risk assets surging. Despite the improvement in risk appetite it still feels as though the market is grasping for direction. The jump in equities is unlikely to prove durable in an environment characterized by various uncertainties about growth and policy, especially the US.

The next hurdle for markets is the US payrolls data tomorrow. Although the ADP jobs report revealed a surprise 10k decline the employment component of the ISM manufacturing survey strengthened to 60.4, suggesting an improvement in August manufacturing payrolls. Ahead of the payrolls release the US data slate today largely consists of second tier releases including July pending home sales, August chain store sales, weekly jobless claims, and factory orders. It is worth paying particular interest to jobless claims given that the four week moving average has been edging higher, suggesting renewed job market deterioration. The consensus is for a 475k increase in claims, which will still leave the 4-week average at an elevated level.

Given that one of the biggest debates raging through markets at present is whether the Fed will embark on further quantitative easing comments by Fed officials overnight were closely scrutinized for further clues. In the event, Fed Governor Kohn highlighted that the Fed’s reinvestment of the proceeds from mortgage-backed securities will not automatically lead to further QE, suggesting some hesitancy on his part. Meanwhile, Dallas Fed President Fisher noted his reluctance to expand the Fed’s balance sheet until fiscal and regulatory uncertainties are cleared up.

Both sets of comments highlight the difficulty in gaining a consensus within the FOMC for a further increase in QE, suggesting that the hurdle for further balance sheet expansion will be set quite high. Moreover, such comments put the onus on Congress to move quickly in clearing up fiscal policy uncertainties.

As markets flip from risk on to risk off almost on a daily basis the question for today is how sustainable the rally in risk trades will prove to be against the background of so much policy and growth uncertainty. Unfortunately today’s data will provide few clues and markets will turn their attention to tomorrow’s US non-farm payrolls report for further direction. To an extent this suggests that it may be a case of treading water until then. Nonetheless, I still maintain that risk trades remain a sell on rallies over coming weeks

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