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Markets are closely watching next week's release of U.S. non-manufacturing economic data following the significant drop in the flash Markit services PMI into slowing growth territory, setting off alarm bells the United States may be heading into a recession.
Strength in the U.S. dollar has been weighing on the local manufacturing sector, hurting competitiveness and demand for U.S. exports.
Australian analysts are closely watching next week's U.S. ISM non-manufacturing Purchasing Managers Index (PMI) following the "horrific" U.S. flash Markit services PMI, which dropped from a prior 53.2 to 49.8, for a similar result would reliably indicate the U.S. economy is heading into a recession.
"If services really does start to follow the manufacturing sector down, that would be a real concern (because) the figures show its not just U.S. dollar strength that's affecting the economy, but you're also going to see some domestic slow down as well irrespective of what's happening in the external market," IG market analyst Angus Nicholson told Xinhua, adding the ISM should be given more weight.
Traditionally, like China's official and Caixin services PMI index, the ISM non-manufacturing PMI needs to drop to between 42 and 43 for the economy to actually be in recession.
"Historically when you look at the correlation between those indices and actual GDP, the recession level is a lot lower," AMP Capital Markets chief economist Shane Oliver told Xinhua.
"We're not there yet, but the fact it's fallen the way it has is obviously a
concern."Oliver argues there is also a danger in reading too much into the February services index as U.S. weather and news around global growth and share market turbulence would have weighed on business mindset.
"Business people hear a lot of bad news and therefore reflect that in their survey responses," Oliver said.
However, if the ISM non-manufacturing PMI does read comfortably above 50, coupled with indications of a stable U.S. manufacturing sector, "that actually bodes quite well for the U.S. economy," Nicholson said, suggesting the strong U.S. dollar isn't weighing on growth.
"That puts that Markit services PMI aside," which is likely an aberration as it was a flash estimate, Nicholson said.
"(The) durable goods number and capital goods number does seem to be portending some stability and turnaround in the manufacturing sector."
"That's actually quite positive, and that means it may give the U.S. Federal Reserve space to actually hike (interest) rates sometime in the second half of the year."
Building the case for a Fed rate hike, markets are also expecting a 195,000 increase in the U.S. non-farm labour market in February - released March 4 - following January's 151,000 job rise, with unemployment remaining unchanged at 4.9 percent, however it is a lagging economic indicator.
"The danger is the Fed might pay too much attention to the jobs numbers in concert with signs of a rise in underlying inflation as we've seen in recent CPI releases and therefore still push on with raising rates even though forward indicators are still softish," Oliver said.
Increasing U.S. inflation is bad news for emerging markets - important for global growth - as historically, U.S. Federal Reserve tightening cycles cause more emerging markets to enter and economic crisis, quickly developing contagion fears that spread to larger economies.
"It's not written in sand, sometimes the crisis takes awhile to come on," Oliver said, adding there is a history of U.S. dollar strength when a new cycle begins which causes some sort of problem.
"That's the real issue here, as the U.S. dollar has gone higher in anticipation of Fed tightening, it's had the effect of squeezing the emerging market borrowers who have U.S. dollar debt, " Oliver said, creating a potential funding crisis as it becomes too costly to service loans.
"It's come at a time when the emerging world is already in stress," Oliver said, noting the significant drops in commodity prices affecting emerging market economies.
The U.S. Federal Reserve's mandate is to control U.S. underlying inflation; hence the beginning of the tightening cycle in December 2015, further strengthening the greenback after it had already appreciated 25 percent. Enditem
