- MarketWatch – Chicago PMI jumps to near three-year high in September
The numbers: The Chicago purchasing managers index rose to 65.2 in September from 58.9 in August, on a scale where any reading above 50 indicates improving conditions. That’s the highest level in three months and close to June’s reading of 65.7, the highest level since 2011. The increase was well above the consensus. What happened: In September, 4 out of the 5 components improved, with the gains concentrated in demand, backlogs and employment. The recent barrage of storms was said to have weighed on delivery times.
Summary
The gap between soft (survey-based) and hard (official release) economic data in the U.S. widened last week. Equities in the U.S. typically followed soft data more closely, and have remained buoyant. But hard data falling below 1-year averages will make it more difficult for soft data to remain afloat. TIPS breakevens widened with risk on flows in September but appear exposed given the underperformance of inflation in the U.S.
Comment
The chart below shows how soft, survey-based data (orange) like the Chicago PMI remain buoyant after stabilizing in August. Yet hard, official release data (blue) has continued to reflect a lack of growth. When we last updated this chart on July 17 we remarked:
Survey respondents remain optimistic and this has helped buoy risk assets which tend to follow soft data. That confidence will be difficult to sustain if hard data falls below 1-year averages.
That is precisely what we are seeing as official release data continue to underwhelm. Survey data has been remarkably resilient, possibly reflecting some of the surging optimism we’ve seen in investment flows. But since 2011, it has been the rare exception that soft measures were able to remain above 1-year averages after hard data fell below.
This relative resilience of soft data measures has helped keep U.S. equities at their highs. And this is consistent with what we’ve seen before. The S&P 500 tracks soft data measures more closely than hard data.
And while exceptionally low volatility across markets, central bank expectations and economic data might keep equities aloft, we think other markets may be more impatient for proof of rising inflation. 5y TIPS breakevens have widened 20 bps since the end of August.
In our regular coverage of TIPS, we have commented on how higher energy prices and strong risk market performance has been the dominant influence behind TIPS widening. And we’ve also noted how inflation expectations rebounded along with the Citi Economic Surprise Index, anticipating improvements in inflation. But after such a spirited widening move, inflation protection markets will be looking for support from strong inflation data.
But inflation data has remained problematic, defying expectations of a being pulled higher by improving soft data. The charts below show U.S. inflation remains a global laggard. U.S. inflation continues to miss expectations, most recently with Friday’s PCE inflation data. Year-over-year core PCE is the Fed’s preferred measure, and the miss offsets stronger than expected August CPI numbers.
The U.S. inflation surprise index (left) remains below zero (1-year average) and is underperforming versus other regions. The inflation data change index (right) shows that U.S. inflation has now fallen below 1-year averages. U.S. inflation growth significantly lags inflation growth in the Eurozone and U.K. This does not strike us as a supportive background for sustained widening in inflation protection spreads.
Conclusion
The gap between survey and official release economic data in the U.S. is widening again. Survey measures have proven resilient, but hard data is now falling below 1-year averages. Since 2011, hard data crosses below 1-year averages have typically seen soft data follow hard data lower.
Resilient soft data has helped push the S&P 500 to new highs and pulled inflation protection markets in the U.S. higher in the process. But inflation data has been uniquely disappointing in the U.S. Rallying crude oil and risk-on flows have been sufficient for the past month. But we think TIPS breakevens will be less patient than equities in waiting for evidence that inflation is rebounding.