Greetings,

Let's start in the United States where the ISM non-manufacturing report missed consensus. While the weakness in manufacturing can be dismissed as being a relatively small portion of the GDP, slower growth in services got everyone's attention. Business activity, exports, and even the employment growth weakened.

Source: Investing.com

Source: ISM

A measure above 50 indicates growth, but this chart clearly says that the US service sector growth has slowed sharply.

It was interesting to see that the ADP employment report continues to show a solid pace of job creation.

Source: ADP

The ISM index on the other hand indicates a softer pace of hiring. The next ADP report may not be as benign.

By the way, the Gallup Job Creation Index also indicates a bit of loss of momentum.

Source: Gallup

And those who didn't think that a strong dollar will not impact the US service sector, think again. Here is the service sector export orders index. That's right, the US exports a great deal of services (consulting, engineering, financial services, etc.)

Moreover, the Services PMI report from Markit confirmed the bad news from ISM.

Source:  Markit

Below is a comment from the Kansas City Fed's Esther George who argues for continuing to raise rates this year.

Source: Kansas City Fed

Well, the US service sector reports above should provide that "substantial shift in the outlook".

She also talked about not responding to each "market blip" in policy decisions. How about the fact that the treasury curve is now the flattest since the early 2008. Enough of a "blip" here?

The market response to the US service sector reports was swift. The Jan-17 Fed Funds futures and the Dec-16 LIBOR futures below show a rising probability of "one-and-done" (no rate hikes this year).

Source: ‏barchart

Source: ‏barchart

Here is the likelihood of a March hike.

Source: ‏@DavidInglesTV

At least one Fed official spoke about the US dollar and the tightening financial conditions. Here are some comments from William Dudley.

Source: Reuters

Source: @fastFT, Goldman Sachs

The biggest response to the disappointing ISM report (supported by the Markit report) was in the FX markets.

1. The US dollar index (DXY) moved sharply lower.

Source: barchart

2. Here is the euro - still waiting for that "parity" we've been promised.

Source: barchart

3. Dollar-yen fell below the post- negative rate announcement level.

Source: barchart

4. The British pound rose sharply on the ISM report, also supported by a better than expected services PMI numbers from the UK.

 

Source: Investing.com

As an aside, since we are on the topic of the UK, the Brexit odds in the betting markets remain above 50% (which will have a massive impact on the GBP). More on this later.

5. Kiwi dollar shot up over 2% vs USD on lower than expected NZ unemployment, some hawkish comments from the RBNZ, and of course the weak US ISM non-manufacturing report.

Source: barchart

Source: Investing.com

6. EM currencies rallied across the board in response to the ISM release. The table below shows US dollar down against all these currencies.

Source: Investing.com

Speaking of stronger currencies, the offshore Chinese yuan was under pressure on Wednesday. The rumor is that the PBoC used the dollar weakness to intervene again and bring the offshore RMB closer to the onshore one.

Source: barchart

By the way, heads up folks... Iron ore prices continue to climb the wall of worry.

Source: barchart

Moreover, here are US-listed mining shares over the past 3 days. Given all the stimulus Beijing is pumping into the economy, these market moves should not be ignored.

Source: Ycharts.com

In other emerging markets the Russian services PMI fell the most in 10 months. Here is the summary from Markit. Just awful....

Source: ‏Markit

Now let's turn to the energy markets where six oil producers supposedly agreed on some sort of an emergency meeting. As discussed before, some nations are getting desperate. This of course is hopeless without the Saudis, but the oil market took it as bullish news. Spurred on by the the sharp drop in the dollar, oil prices jumped. The move up was 8.4% - as we begin to get used to this spectacular daily volatility.

Source: barchart

The near-term fundamentals for crude oil however remain terrible.

1. US crude oil inventories hit new highs (the only time inventories in storage were higher was in the late 1920s) 

 

2. The US continues importing more oil, putting further upward pressure on inventories.

3. US crude oil production has not yet declined below last year's level.

4. As discussed yesterday, US gasoline inventories hit record highs. Just take a look at this spike.

5. Related to the above, here are the US ethanol inventories.

In spite of these trends, some analysts are forecasting a 50% increase for oil by the end of the year. Perhaps. 

Source:  ‏@business

The equity market certainly doesn't believe it. The energy sector price-to-book ratio has collapsed as the market discounts these companies' book values. If these discounts are overdone however and the forecast above is correct, we are in for an unprecedented rally in energy names (where asset managers remain severely under-invested).

Source: BAML

Staying with commodities, it's been a good start of the year for gold as the Fed's rate hike expectations are getting pushed further out.

There are some other bullish indicators for gold. Here is Macquarie's estimate of China's gold imports.

Source: Macquarie

Also it seems that China's commercial banks are buying up gold. Isn't that against the Volcker rule? Oh wait, wrong country ...

Source: Macquarie

Now a couple of comments on Japan.

1. The 5yr JGB yield is drifting further into negative territory. Amazing.

2. Japan apparently halted the sale of 10-year (and shorter) JGBs to the public (supposedly not to torture them with negative rates). The only major buyer now is the BoJ.

3. In order to avoid hitting the enormous (QE-driven) reserves (that banks hold with the BoJ) with negative rates, the central bank decided to "grandfather" the existing reserves, "taxing" only some (not all) of the fresh reserves (from future QE) with negative rates. Otherwise, the banking sector revenue will take an immediate hit. Here is a nice chart from the Economist.

Source: @EconBizFin

Now we have a couple of developments in the equity markets.

1. Bank shares continue to get pounded as economic growth (and demand for credit) expectations shift lower and the yield curve flattens (reducing bank interest margin).

Source: ‏Ycharts.com

2. Here are the shares of US homebuilders relative to the S&P500. This is pricing in weak demand for higher-end homes in particular.

 ‏Source: Stockcharts.com

Finally, this is the US velocity of money (nominal GDP over the broad money supply). Will this be the year the velocity of money bottoms out? Perhaps.

Turning to Food for Thought, we have 4 items this morning:

1. Our friend Mike sent over this chart showing the history of the banking sector consolidation in the United States.

Source: realitieswatch.com; h/t Mike

2. The negative impact of a strong US dollar, especially on manufacturing, is hitting some key "swing" states in the US presidential elections.

Source:  ‏@business

3. Facebook's transition to mobile...

Source: @jpmorgan, h/t Jake

4. Wages in many industries are too low for the employees to feed their families, requiring government assistance.

Source: @EconomicPolicy, @pdacosta