US ISM manufacturing weaker, but not as weak as feared; Still, components are consistent with a developing economic recession. As a further indicator of recession, US 2s10s fall deeper into negative territory, now minus 30bps

Media reports that Pelosi will visit Taiwan have spooked the market a little, with some assets affected by more than others. The yuan is weaker, but there hasn’t been much spillover into the NZD or AUD, both trading higher, albeit against the backdrop of a weaker USD. The positive turnaround in the yen continues. Some risk-off vibe has helped a further modest rally in US10s, seeing the rate fall to its lowest since April and making the 2s10s curve even more inverted.

There have been two key news items of interest overnight, Pelosi’s pending visit to Taiwan and US ISM data. A number of sources, including Taiwan media, have suggested that US House Speaker Pelosi is expected to visit Taiwan from tonight and will meet Taiwan’s President on Wednesday, although the US and Taiwan are still “preparing for last minute changes”. China has previously warned against the visit from such a high-profile US government official and has threatened military action. China’s Foreign Ministry spokesman said that the army “won’t sit idly by”, while Chinese media suggest that the army would respond aggressively, possibly sending warplanes over the island.

The US ISM manufacturing index fell to its lowest level in more than two-years to 52.8, but by not as much as feared, with the consensus expecting a drop to 52.0. On the weak side, new orders remained below the 50 mark for the second consecutive month, falling to 48.0, and there were signs of inventories expanding, rising to their highest level in four-decades. The new orders less inventories index is widely monitored, and this fell to a level consistent with economic recession. On the positive side, the employment index increased to 49.9, while weaker commodity prices helped drive the prices paid index from 78.5 to 60.0.

Despite the threat of World War III, US equity investors took the news in their stride. While opening about 0.8% weaker, the S&P500 recovered and until a couple of hours ago was actually up for the day.  The index has since fallen back and is currently down modestly.

We don’t normally discuss Germany retail sales in this report as the figures are volatile and subject to heavy revisions, but for the record they fell by 8.8% y/y in real terms in June, the weakest result since this index began in 1950. The data could result in a downgrade to last week’s GDP figure for Q2, which showed a flat result, and this might signal the start of Germany’s recession, ahead of some serious economic pain as winter approaches, with power rationing risk overhanging the economy.

A risk-off vibe overnight has supported the bond market, with key European and US 10-year rates down in the order of 3-4bps. The US 10-year rate has traded as low as 2.58%, a level not seen since April, now currently at 2.61%. The short end of the curve has been less affected by the news and the US 2-year rate is up 2bps, the 2s10s spread falling deeper into negative territory, now at minus 30bps.

Commodity markets haven’t taken the news so well, and oil prices are down in the order of 4-5%, with Brent Crude trading back below USD100 per barrel. Data showing weaker China PMIs have added to the gloom in the oil market as China’s economy continues to look to be on the ropes.

The yuan is about 0.5% weaker but so far there has been little spillover to the NZD and AUD. Both currencies have started the new week on a positive footing, the NZD rising to as high as 0.6350 overnight and currently at 0.6330. The AUD met some resistance just under the 0.7050 mark and has settled around 0.7020. CAD is weaker on the lower oil prices.

The yen has continued its strong run, supported by lower global rates and speculators unwinding short positions. USD/JPY is down 1% to below 132. NZD crosses are all higher, apart from a fall in NZD/JPY.  Despite the risk-off vibe, the USD remains on the weak side, with EUR and GBP showing modest gains, signalling that the market is paying more attention to US economic data and the rising risk of a “real” recession there, than the USD simply being kicked around by risk appetite.

The domestic rates market was quiet yesterday, with the NSW holiday in Australia not helping. Rates were 1-2bps higher across the swaps and NZGB curves. Given offshore moves overnight, the bias for rates on the open will be for a modest decline.

In the day ahead, the RBA remains well behind the curve and is widely expected to hike its cash rate by 50bps to 1.85% and this is well priced. A full forecast update comes Friday in its Statement of Monetary Policy. The Bank will have to lift its inflation profile and lower its near-term unemployment projection, with the focus on whether the forecasts show a credible path back to the target range for inflation. Today we get more Fed speak, with Evans fronting the media, while the JOLTs report on job openings and quit rates will provide important colour on the US labour market.