Breeding Doves


  • Doves are flocking to Wall Street with odds of a rate cut at the September FOMC at 92%, up from 50% last week; fear of a global recession escalates as the number of countries with factory sectors in contraction at a two-year high led by developed, not emerging, economies
  • Two critical downside risks emerged in the U.S. May Manufacturing PMI via a 13-month high in Customers’ Inventories and a 3-year low in Backlogs; these developments present downside risk to June New Orders and Employment
  • Investors should approach the industrial sector with caution as trade war realities pressure an already-slowing economy; markets will be hyper-focused on today’s Powell remarks and Clarida’s tomorrow with an eye to validating Bullard’s contention that a rate cut is warranted


Don’t call it the turtle dove or the Carolina pigeon. The American mourning dove is one of the most abundant and widespread of all North American birds. One of its most unusual characteristics is the whistling sound its wings make upon take-off and landing. Want to race? It can also pace you on a 55 mile-per-hour highway. The mourning dove is also a leading gamebird, with more than 20 million shot annually in the U.S., both for sport and for dinner. Its ability to sustain its population would be pressured if not for its prolific breeding; one pair of love doves can raise up to six broods of two young each in a single year. That’s a lot of doves.

Doves are breeding with fervor in financial markets as well. The overnight indexed swap (OIS) curve was pricing a 92% chance of a quarter-point Fed rate cut at the September meeting. One week ago, this was a coin-flip probability. Bull steepening of the yield curve has taken hold, and maturities out to seven years all closed under 2% yesterday. In a note to clients, J.P. Morgan economists capitulated by calling for a 50 basis-point cut in rates in 2019’s second half. The bank’s rates strategists lowered their year-end 10-year Treasury target to 1.75% from 2.45%.

Some of the dove converts have been swayed by the onset of the global industrial recession. In May, of the 41 countries we track, 18 manufacturing purchasing managers’ indices (PMIs) posted contractions — readings below the breakeven 50 mark. This was the worst showing since the last industrial recession in 2015-16. Moreover, it also matched the worst breadth of that period, too. In other words, contagion didn’t spread any further and things didn’t get any worse after the April 2015 month of maximum pain.

There are two noticeable differences between then and now. In 2015, emerging market (EM) countries led the decline in global industrial activity with China at the epicenter. The IHS Markit EM manufacturing PMI was 49.5 in April 2015 compared to 50.4 in May 2019. In the current episode, developed market (DM) economies are the largest gravitational force with Germany the focal point. The IHS Markit DM manufacturing PMI registered 51.9 in April 2015 and clocked in at 49.2 in May 2019.

Second, trade war tensions between the U.S. and China have painted the backdrop through May. But it’s the fresh escalation from the U.S. aimed at Mexico that risks exerting more downward pressure on the global industrial complex into June. Prepare yourself, the global industrial recession is likely to get worse before it gets better. And the nation in the crosshairs that is most at risk of disappointment is the U.S.

The May ISM manufacturing report presents two downside risks to New Orders and Employment, both of which are components of the headline ISM index.

First, the May increase in the ISM Manufacturing Customers’ Inventories index to a 13-month high suggests further weakening in New Orders come June. Customers’ Inventories act as a short-run leading indicator for the bellwether New Orders index. They have an inverse relationship with New Orders, as in, the lower, the better. When buyers say they have too little product on hand, they usually order more. And when they have too much supply, they are apt to order less – this is what’s unfolding now.

Second, the May drop in the ISM Manufacturing Backlog index to a three-year-low risks outright declines in the June Employment index. The Backlog index is a short-run indicator for the Employment index, with a one-month lag being the strongest determinant. The latest observation is the first drawdown reported since 2016, the last time industrials tanked. As a rule, when unfilled orders are bulging, manufacturers require additional bodies to complete the work. But when backlogs are depleted – as is the case today – the need for labor is reduced. This can take the form of fewer hours, fewer workers or some combination of both.

Caution is warranted for those investors brave enough to dabble in the U.S. industrials sector on the basis of valuation. While the performance of the S&P Industrials ETF (ticker XLI) is running slightly ahead of year-ago levels, locking in gains would seem to be a sound strategy.

More industrial weakness will breed more doves. St. Louis Fed President and 2019 voting FOMC member James Bullard has already taken flight, saying yesterday that a rate cut “may be warranted soon.” Count on him to dissent at the June 19 FOMC meeting if Powell waxes hawkish.

Better yet, if you happen to be in the audience this morning at Jay Powell’s Chicago Fed speech, you might warn him that refuting Bullard’s dovishness will not be welcomed by anxious market participants. As for your portfolio in the interim, please plan accordingly.

Posted in Daily Feather.