Slumping Chicago PMI 8211 Ignore or Follow

The 14-pt drop in the February Chicago PMI to 45.8 is the biggest decline since October 2008 and the lowest level since Jul 2009. The sharp fall is attributed to inclement weather conditions (North East) and port-related delays (West Coast). Employment, new orders and production components all fell to contraction territory. To what extent will nationwide factors (weather & port strikes) will impact next week’s release of the February jobs report remains a question for the Fed meeting a few weeks later.

Optimists hold that previous sharp declines in the Chicago PMI were followed by strong rebounds, but we must note the positive correlation between the Chicago PMI and the manufacturing ISM (due Monday), which could imply a figure of sub-50 in the latter versus expectations of 53.2.

The last time the index fell by more than 10 points was in October 2008, when the financial crisis unleashed brought a standstill to manufacturing activity and jobs losses escalated for the months to follow. If the chain reaction of disappointing Chicago PMI ==> weak manuf ISM ==> sub 200K in NFP materializes next week alongside weakness in average hourly earnings, then the FOMC would find little reason to drop the patience guidance in March.

Dudley warns of premature rate hike

So far this year, the voting members of this year’s FOMC (San Francisco’s Fed Williams, Atlanta Fed’s Lockhart and Richmond Fed’s Lacker) have all spoken in favour of raising rates in June, by highlighting the dangers of waiting too long before starting to normalize rates. Until today, Chicago Fed’s Evans was the only dovish voter who said the Fed “shouldn’t be raising rates before 2016 if things transpire as [he is] expecting”.

FRBNY president Dudley broke the silence and gave his first speech of the year, stating the “risks of lifting the fed funds rate off the zero lower bound a bit early are higher than the risks of lifting off a bit late. This argues for a more inertial approach to policy.”

Yields still at odds with Fed

Considering that most FOMC member forecasts expects rates above 2% by end of 2016 compared to the bond market’s 1.5% view, then a decision by the FOMC to drop “patience” from the March FOMC will trigger a sharp catch-up in bond yields, that will provide detrimental to equities in April-May, as has usually been the case over the last 5 years each time June coincided with the end of a Fed stimulus package.