The US Manufacturing PMI flash recorded 49.5, below the estimated 52.7. The Services PMI flash reported 55.2, surpassing the expected 53.0. Last month’s figures were 52.9, with the composite flash at 54.6 compared to 52.9 from the previous month.
The data suggest the US economy expanded at a 2.3% annualised rate at the start of the third quarter, an improvement from the 1.3% rate of the second quarter. However, this growth was uneven, reliant on the services sector, as manufacturing conditions worsened due to declining benefits from tariff actions.
Business Confidence and Inflation Pressures
Business confidence about future prospects has diminished in both manufacturing and services sectors, reaching one of the lowest points over the last two-and-a-half years. Concerns persist over government policy impacts, including tariffs and federal spending cuts. Inflation has intensified, with costs attributed to tariffs and increased labour expenses due to shortages.
Selling prices in July experienced one of the highest increases in three years. This suggests that consumer price inflation may continue rising, surpassing the Federal Reserve’s 2% target. As price hikes affect households, further inflation is likely.
Based on the latest data, we see a clear split in the American economy that presents trading opportunities. The overall growth is being propped up entirely by the services sector while manufacturing is now contracting. This divergence suggests a strategy of favoring services-related companies over industrial and manufacturing names.
Economic Divergence and Trading Strategy
This two-track economy is confirmed by other recent reports, with the May ISM Services PMI surging to a strong 53.8 while its manufacturing counterpart languished at a contractionary 48.7. We believe traders should consider long positions in services-focused ETFs and potentially short positions in industrial sector funds to capitalize on this widening gap. The data indicates this trend is accelerating, not slowing down.
Mr. Williamson’s commentary on deteriorating business confidence is a significant warning sign for us. This drop in sentiment, linked to government policy and tariffs, suggests that downside protection is now prudent. We should look at buying put options on broad market indices like the S&P 500 to hedge against a potential downturn if these concerns escalate.
The intensifying inflation pressures he highlighted are also critical, especially with core inflation remaining stubbornly above the Federal Reserve’s target. His prediction that consumer prices will rise further puts the central bank in a difficult position. This could force a more hawkish stance than the market currently expects, even with a weakening factory sector.
This combination of economic divergence and potential central bank surprises creates an environment ripe for increased market volatility. Historically, such uncertainty has caused the VIX to spike, as seen during the rate hike cycle of 2022. We believe it is wise to consider purchasing options that benefit from a rise in volatility, such as VIX calls or straddles on major indices.
