In the US, the risk of recession seems to have retreated

Outlook: Today’s is jobless claims (expected up to 259,000 from 256,000 a week earlier) ahead of the big kahuna tomorrow, nonfarm payrolls. The markets are suspiciously quiet and in a narrow range, with a lull like this usually preceding some fancy volatility and sometimes a breakout.

Risk sentiment is not exactly on a knife edge, but it’s not taking a clear direction either. If we take the S&P as a bellwether, risk appetite is on an upswing and we see that in the CAD/AUD/NZD, too. This is not a commodity play but rather a growth play, with the AUD notably reflecting growth in Asia generally and China in particular, despite scare stories about China stumbling. If it’s buying iron (but not coal), it’s hardly on its sickbed.

In the US, the risk of recession seems to have retreated now that the ISM services PMI unexpectedly rose to 56.7 in July from 55.3 in June and beating market forecasts of 53.5. Trading Economics notes output and new orders rose while employment fell only a little and price pressures eased (72.3 vs 80.1). Not so much fin–inventories fell at a faster pace (45 vs 47.5). “Availability issues with overland trucking, a restricted labor pool, various material shortages and inflation continue to be impediments for the services sector”, Anthony Nieves, Chair of the Institute for Supply Management said.”

This nugget of information perfectly reflects the cloud of ambiguity surrounding risk sentiment. “Good but can get worse” or “Not bad yet.” This is reflected in the comments from above about the S&P: According to Bloomberg, “The recent brisk rebound in equity markets won’t last as macroeconomic data continue to deteriorate and earnings forecasts are being slashed, strategists at Goldman Sachs Group Inc. and Sanford C. Bernstein warn. ‘Without clear signs of a positive shift in macro momentum, temporary re-risking could actually increase risks of another leg lower in the market rather than signal the end of the bear market.’”

So we are looking for “macro momentum” and not likely to get it from payrolls. While the pace of the next equity index move is developing in its chemicals, we have the bond market to watch. Recently we saw the 10-year yield move up about 25 points and hang on to it. Meanwhile, the Bund slid back under 1% and is staying there.

We are seeing an emerging divergence in economies and in yields that has to come home to roost at some point. We are inclined to think the US can hold out longer on the economy than the gloomsters think, so that Europe’s innate deeper weakness should drag the euro down–but not until the Fed dove camp gives up. This gets twisty because when the US economy looks okay and the stock market is fat, dumb and happy, risk gets a lower score and the dollar is shunned. It’s not a little weird that bad economic data would make the dollar looks more like a safe haven and thus to be accumulated. This is how European economic data can be disregarded in favor of all US, all the time. We used to call this the “Teflon euro” but it’s really the “sticky dollar,” with bad news clinging to the US and getting overrated.

Bottom line, we think the nascent yield and dollar rallyette are fading. It’s not time to take any sizeable positions.

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