ISM punished by USD CNY weakens further

The broadening decline across all components of the January manufacturing ISM survey highlights the early signs of punishment from the rising USD on US factories, orders, jobs and prices. Aside from the prices paid index resuming its downward spiral to reach fresh six-year lows, the exports orders component fell into contraction zone (below 50) for the first time since November 2012.

Considering that net exports component of US Q4 GDP slowed to 2.8% from 4.5% in Q3 and 11.1% in Q2, and with ½ of the BRICs (Brazil and Russia) heading into recession and the other half remaining in slow mode, the external threat to US growth is being compounded by the double hit from an appreciating currency and slowing GDP growth.

Unlike in recent Eurozone–related falls of confidence in 2010, 2011 and 2012 when the USD rose against all currencies with the exception of the Japanese yen, today’s currency strength in the greenback has been broad-based, but demand from China and the rest of the BRICS isn’t what it used to be. When the Fed mentions the dollar next, it will be in the context of slowing global growth rather than merely a translation effect of US earnings.

China PMI contraction weighs on CNY

China’s manufacturing PMI did not escape the bad news either, when the January index fell in contraction territory for the first time since June 2012 at 49.8 from December’s 50.1.

The private version of the China’s PMI as prepared by HSBC showed a rise to 49.7 in the final reading for January from 49.6 in December, with downward revisions in new orders and new export orders saw downward revisions, but still signalled marginal expansion. The figures support the notion of manufacturing weakness, which opens the door for more aggressive monetary and fiscal easing from Chinese authorities.

The Chinese PMI figures further fuelled existing speculation of CNY devaluation. But remarks from the People’s Daily, the government’s daily mouth piece newspaper indicated China should stick to making full use of the current 2% trading band. This could mean that the offshore rate will continue to weaken within its daily 2.0% threshold from the central reference rate in order to affirm continuity in currency liberalization, while attaining gradual depreciation. That is already reflected in the spread between the offshore rate and the PBOC’s reference rate hitting a new all-time high, which should likely lead to the 6.40 later this quarter.

The path towards prolonged CNY weakness is here to stay, and so is the road to deflation in the Eurozone and the US.