U.S. factory activity contracted in August for the first time in six months as new orders and production tumbled, but a low level of layoffs continued to point to a pickup in economic growth in the third quarter.
A reading below 50 indicates a contraction in manufacturing, which accounts for about 12% of the U.S. economy. The dollar's surge between June 2014 and December 2015 as well as weak global demand have crimped export growth. A collapse in oil drilling activity following a plunge in oil prices has also squeezed manufacturing by undermining business spending, leading to weak demand for heavy machinery. In addition, a U.S. inventory correction has resulted in factories receiving fewer orders.
In a separate report, the Labor Department said initial claims for state unemployment benefits increased 2k to a seasonally adjusted 263k for the week ended August 27. It was the 78th consecutive week that claims remained below the 300k threshold, which is associated with a robust labor market. That is the longest stretch since 1970, when the labor market was much smaller.
The downbeat factory data pushed the dollar lower against a basket of currencies. U.S. stocks were generally weaker, while prices for U.S. Treasuries rose.
The data came ahead of the release on Friday of the government's closely watched employment report for August. The market expects that nonfarm payrolls increased by 180k jobs in August after rising by 255k in July. In our opinion the increase may be even slightly weaker (170k). Unemployment rate is seen falling one-tenth of a percentage point to 4.8%. August's anticipated step-down in job gains would follow two straight months of payroll increases above 250k.
Cleveland President Loretta Mester said keeping interest rates low in the United States will likely do little to resolve deep-set problems in the country's labor market. She said she did not share the view labor activists delivered to Fed officials last week that low interest rates could help resolve racial income and employment gaps in America. She did not comment on when the Fed will next raise interest rates.
We continue to be fundamentally on the USD as we still see it as overvalued. In the event that the report surprises on the downside, this would compound the concerns that surfaced yesterday on the back of the sub-50 ISM reading; the market would push back the odds of a December hike and pressure on USD would intensify. If the report surprises on the upside, the dollar is likely to rally as a knee-jerk reaction but quickly run out of steam. We expect higher today and keep our EUR/USD bid at 1.1085.
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