ISM Manufacturing PMI Preview: Three reasons for an upside surprise

• Economists expect a minor decline in the ISM Manufacturing PMI, despite upbeat data from S&P Global.
• Calm in the banking sector may have encouraged purchasing managers to provide a more optimistic view. 
• Prospects of falling rates may have also contributed to a stronger outcome, yet that also limits any USD gains.

Calmer after the storm? Investors have been cheering the lack of bad news from the banking sector – and its outcome for monetary policy, fewer interest rates. This optimism may have reached businesses in the manufacturing sector, which has other reasons to celebrate. Nevertheless, Dollar bulls' party may be short-lived. 

Here is a preview of the ISM Manufacturing Purchasing Managers' Index (PMI), due out on Monday, April 3, at 14:00 GMT.

What economists expect for the March ISM Manufacturing PMI

ISM's forward-looking survey provides a snapshot of sentiment in the industrial sector, which is small in comparison to the services one. Nevertheless, the early publication provides insights about employment, inflation and growth.

The focus is on the headline figure, as the Federal Reserve (Fed) wants to see a broad cooling down of the economy. In the past, the employment component was eyed as a hint for the Nonfarm Payrolls (NFP) report, while the Prices Paid figure served as a leading indicator for the Consumer Price Index (CPI). With no specific topic standing out, the headline will be eyed. 

Contrary to the bustling services sector, manufacturers have continued suffering from the reopening recovery, which means people are enjoying travel and leisure rather than equipping their houses with products. The ISM Manufacturing PMI slipped under 50, the threshold separating from contraction.

Source: FXStreet

After scoring 47.7 in February, economists expect further deterioration to 47.3 points in the fresh report for March. Here are three reasons why this seems misguided:

Three reasons to expect a stronger ISM Manufacturing PMI

1) Parallel figures are upbeat

S&P Global has already released its preliminary Manufacturing PMI, which surprised to the upside. For long months, this firm's figures were more downbeat on the sector. Back in February, S&P Global showed a score of 47 vs. 47.7 for the ISM Manufacturing PMI. But in March, the initial release came out at 49.3, a considerable surprise. 

Source: FXStreet

Manufacturing PMIs in Europe have also exceeded estimates, pointing to a global bounce in manufacturing. Despite geopolitical tensions, globalization is alive and kicking, and there is  reason to also expect a better outcome in the US. 

2) The banking crisis has eased

PMIs are surveys, and they reflect sentiment. One reason to expect a decline is the banking crisis, which scared investors from California to Switzerland and beyond. Fear of finding further skeletons in banks' closets seems to have failed – at least at the time of writing. A case in point is Deutsche Bank, which suffered an attack by "vigilantes" only to be scooped up by bargain-seekers.

I want to stress that new issues may still arise between publishing this article and the publication of the data. Nevertheless, I would lean toward the words of the Fed's James Bullard, who said the crisis is 80% over. 

Renewed optimism should boost sentiment and push the figure higher. 

3) Fed hikes seem to be over

Even if the banking crisis fully subsides, it has taken away one pain point for businesses – prospects of higher interest rates. A week after the publication of the previous ISM Manufacturing PMI, Fed Chair Jerome Powell told lawmakers that the pace of rate hikes could be accelerated. Then came the collapse of Silicon Valley Bank (SVB) and caused policymakers to opt for a smaller 25 bps hike increase in borrowing costs. Powell admitted they considered a pause. 

Bond markets are now pricing the end of the rate-hiking cycle. Such talk, prevalent on financial media, serves as another boost for sentiment. Uncertainty about banks has resulted in more certainty about the peak in interest rates – and businesses love certainty. 

Expected Market reaction to the ISM Manufacturing PMI

If the analysis above is correct and the headline figure beats estimates, the US Dollar would rise and stocks would decline as investors would give a higher chance to a rate hike in May. However, any such move would be short-lived. Even if the Fed were to raise borrowing costs next month, it would probably be the last. 

Markets are likelier to "buy the dip" on such a fall, while any US Dollar advance would be short-lived. 

If the ISM MAnufacturing PMI exceeds the 50-point threshold – indicating fresh growth – the impact of the release would be more significant and the bounce-back longer. The chances of a leap from 47.7 to above 50 are lower than a small advance toward the threshold.

If my analysis above is mistaken and the data disappoints, stocks would rise on growing certainty of the Fed pausing and then cutting rates. The US Dollar would fall and remain low. This scenario has lower chances as well.

Final thoughts

The ISM Manufacturing PMI release kicks off the calendar for April after end-of-quarter flows on Friday and could trigger significant volatility. The publication on Monday could shape trading for long days until the ISM Services PMI is due out on Wednesday.