SCOREBOARD: Manufacturing blues

Back from the Labour Day holiday, US markets were mixed following a weaker-than-expected manufacturing ISM report. In contrast to forecasts for a rise to 50, the index fell to 49.6 from 49.8. This is the third month below 50 and is a signal for worry. I certainly don't dismiss it.

But before all the worms come out of the woodwork, it pays to actually understand what a number below 50 means. Obviously it's a sign that the manufacturing sector is contracting, although some of the hard data still remains more positive. Watch this space – it is a sign only, not categorical proof. For the economy more broadly, the ISM suggests an index of 49.6 is consistent with growth at 2.4 per cent – or around trend.

So that's consistent with the GDP figures we've seen over the last few quarters. And that is confirmation of trend growth. Maybe offsetting that news was the huge double digit growth rates recorded by US car makers in August – Toyota up 46 per cent, GM and Chrysler up 10 per cent to 14 per cent.

In any case, falls were generally modest with the S&P off 0.1 per cent (1404), the Dow down 0.4 per cent (13035), while the Nasdaq rose 0.3 per cent (3075). The damage done to commodities was fairly minor too, and while crude fell a solid 1 per cent or so ($95.55) gold was up another $10 (1698) and silver shot up 3 per cent because you know that QE3 to infinity is a done deal.

Over in Europe, those comments from Draghi about bond buying I mentioned yesterday saw a sharp fall in Spanish and Italian yields overnight – must be quite a few US holders – and short end yields slumped – the Spanish 2-year down 45 bps to 3.02 per cent. The 10-year yield was off about 20 bps for Spain (6.56 per cent) and 10 bps or so for Italy (5.58 per cent). European equities were however weaker (-1.2 to -1.6 per cent). For the US, treasuries did little – the 10-year at 1.57 per cent, the 5-year at 0.62 per cent and the 2-year at 0.24 per cent. Australian futures were off 2 to 3 ticks with the 3s at 97.57 and the 10s at 96.97.

Otherwise for the price action we saw Australian dollar off about 50 pips, following that post RBA spike, and it sits at 1.0225 as I write. Euro fell about the same, to be at 1.2564, while sterling and Yen are at 1.5873 and 78.4 respectively.

Not really much else to report for overnight, so I'll turn to the RBA's decision yesterday. The decision to keep rates steady was obviously widely expected, although the consensus appears to be that more rate cuts will come. That may end up being the case, and I did detect a slightly more bearish tone to the board's statement yesterday, although overall the press release was little changed from last month. So when I say slightly I mean ever so slightly. The board still see global growth at around trend this year and described the domestic economy as being around trend as well. Both the same as last month, although they emphasised the downside risks to the globe more directly this time and of course the domestic assessment continues to be an understatement. Domestic demand, which is what the cash rate influences, is actually growing well above trend (5 per cent year-on-year).

Other than that, the only eyebrow raising moment was the board's assertion that some of the strength in consumer spending has been temporary. This a common misconception with no factual backing, so I am surprised the board mentioned it. Why state something that isn't true? As I said, ever so slightly, but we do need to be careful on this issue. It was only recently that the lie of consumer weakness, that I exposed through 2011, was begrudgingly accepted as such by the consensus.

At this stage then I still don't think calls for further cuts are really based on anything. The economy is above trend, the terms of trade are still exceptionally high, the unemployment rate is low and the labour market still very tight – despite repeated forecasts for a rise in unemployment. Moreover the Australian dollar has come off and no one can state categorically that is significantly overvalued, or argue that it is harming the overall economy (which is growing above trend). More to the point, underlying inflation, which I estimate is sitting at 2.5 per cent (higher than the RBA's estimate of low 2's) has likely troughed. At the very least the risks are evenly balanced.

In contrast the ‘case' for lower rates I've seen from lobbyists, industry reps and political propagandists are based on outright lies, a disingenuous discussion of data and forecasts, which history has shown have been repeatedly wrong. But then again these people don't have the national interest at heart.

On purely economic grounds then, I suspect the RBA will remain on hold with the data as it currently stands. Having said that, I'm still very unsure as to what paradigm the board are operating on given their panic cutting since late last year. None of the ‘insurance' was needed as it turns out (it was actually confidence destroying) and it was done at a time of rapid economic acceleration. I still think they can be unduly swayed by the news flow then, as there is no other way to rationalise those cuts – the behaviour is very erratic.

On to the day ahead, we get GDP at 1130 AEST and indications to date are that we'll get a very good number: 0.7 per cent to 1 per cent. Partial indicators suggest strong household consumption and decent net export contrition. One of the more interesting features was the strong lift in public spending. There is certainly no fiscal contraction underway as was argued would be the case by many Australian economists. Indeed government spending continues to accelerate.

Looking abroad, eurozone retail figures are due alongside the lower tier services PMI. Then in the US, unit labour costs and productivity are out.

Adam Carr is a leading market economist. See Business Spectator's glossary for definitions of technical terms used in SCOREBOARD articles.

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