America’s manufacturing industry suffered the sharpest slowdown last month since the depths of the global financial crisis, prompting calls for emergency rate cuts to avert a spiral into recession.
IHS Markit’s momentum gauge fell to the lowest since September 2009 as America’s fortress economy succumbed to fading fiscal stimulus and mounting damage from trade wars with China, Europe, and Mexico.
Chris Williamson, the group’s chief economist, said US profit margins are being squeezed. Manufacturers are cutting output and laying off staff. “Surging order book growth just a few months ago has now turned into contraction – the first such decline seen in the series’ 10-year history,” he said.
“There is still time for the US Federal Reserve to right the ship, but time is running out,” said Michael Darda from MKM Partners.
He said the yield curve for US Treasuries is inverting across every relevant maturity, flashing a red warning sign. “Long-cycle” indicators such as housing and car sales are already slipping into a deepening downturn.
“It’s time for the Fed to take out an insurance policy with a 75-100 basis point rate cut. If the Fed sits on its hands and a full-blown recession gets underway, taking rates all the way back to zero may not be enough to revive growth. An ounce of prevention beats a pound of cure,” Mr Darda said.
The M1 money supply has stalled over the last eight months yet the Fed is still engaged in quantitative tightening, or the reverse of quantitative easing. This is draining dollar liquidity at home and across the world.
“The US is now on recession watch,” said Edward Harrison from Credit Writedowns. “I don’t think the Fed will pivot aggressively. It will end up over-tightening and creating a credit event. Trump’s policy moves are potentially the thing that tips this into recession.”
The central bank gave no indication in its minutes in late May that it would soon come to the rescue. The hawkish text suggested that the US economy is rude good health despite “transient factors” and that some voting members are even itching to raise rates.
This was a nasty surprise for markets counting on a monetary comfort blanket. Investors had already priced in two cuts in the federal funds rate over the rest of this year.
They are now trying to bounce the Fed into a fresh policy capitulation. Torsten Slok from Deutsche Bank said futures contracts are betting on an 85pc chance of a rate cut by September. There could be a brutal reckoning on Wall Street if the Fed refuses to comply.
“The US stock market is an accident waiting to happen,” said John Higgins from Capital Economics. “We think the bond market is simply running ahead of the stock market. Equities will ‘catch up’ in due course. We expect the S&P 500 to decline by another 17pc before the year is over.”
Hans Redeker of Morgan Stanley said the Fed was asleep at the wheel as rate expectations collapse, oblivious to the “new reality” of global trouble ricocheting back into the US economy and hitting businesses.
Traders were shocked by comments this week by Mary Daly, the San Francisco Fed president, stating that the US economy is in a “really good place,” and that the inversion of the yield curve is largely meaningless.
Such assurances have echoes of the Fed’s nonchalant attitude as the subprime crunch turned serious in 2007, when monetary policy was kept too tight for too long.
Robert Hetzel from the Richmond Fed said it was the Ben Bernanke-run Fed itself that caused the Lehman crisis by letting the money supply slow drastically.
The big global banks have cut their forecasts sharply over recent days. JP Morgan expects the darkening picture to trigger two rate cuts over the next six months regardless of what the Fed says this week, with yields on 10-year US Treasuries dropping to 1.65pc by early next year.
Christian Keller from Barclays said the outlook is bad enough to warrant 75 basis points in cuts over the second half.
The historical pattern is that once the slow-footed Fed starts to cut in earnest it is already too late. Recession typically follows within four months.
The risk of the policy error has never been so great. Central banks across the developed world have little policy ammunition left to confront a serious crisis. It typically takes 500 basis points of cuts to lift the US economy out of recession: the Fed has barely more than 200 play with. Rates in the eurozone are stuck at minus 0.4pc and cannot go any lower. Europe is trapped.
President Trump has already played his fiscal card. The sugar rush from his tax cuts is fading fast. The stimulus came too late in the economic cycle to have a “multiplier” effect. It failed to achieve a self-sustaining lift in investment by US corporations.
The US is now saddled with a $1 trillion budget deficit in a slowing economy. The Peterson Institute says the “fiscal cliff” this year is the steepest in four decades and will deliver a violent jolt unless Congress passes a fresh stimulus package.
The Democrats control the House and are in no mood to do Mr Trump any favours. If the US economy falters, nobody else in the world can pick up the baton – as China did in 2009. This time China’s downturn is deepening, while Europe and Japan are still in manufacturing recession.
It could be a turbulent autumn for world markets.