Diverging PMIs as US Shows Resilience, Euro Area Falters

Global Economic Divide Widens Dramatically

A stark economic divergence is playing out on the global stage, with the United States demonstrating surprising resilience while the Euro area grapples with significant headwinds. Latest Purchasing Managers' Index (PMI) data reveals a growing chasm, painting a picture of two vastly different economic landscapes.

The Eurozone's composite PMI for May plummeted to 47.5, a figure firmly entrenched in contractionary territory and below the 48.8 consensus expectation. This downturn was primarily fueled by the services sector, which experienced a sharp decline to 46.4, with particular weakness observed in France. Manufacturing offered a slight reprieve, holding in expansionary territory at 51.4, largely due to companies working through existing order backlogs from before recent geopolitical events.

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However, price pressures are mounting. Input costs surged across both sectors, though the data on output prices suggests that an immediate, widespread inflation surge is not yet apparent. Despite this softening growth outlook, markets still anticipate the European Central Bank (ECB) will proceed with a 25 basis point rate hike in June. Nevertheless, the deteriorating growth figures introduce a degree of uncertainty, making further tightening beyond June a less certain prospect.

US Economic Engine Continues to Churn

Across the Atlantic, the US economy presented a much more robust picture. Business activity remained solid in May, with the composite PMI holding steady at 51.7. Manufacturing output delivered a particularly strong surprise, accelerating to 55.3. Service sector growth also remained consistent at 50.9.

While new orders and prices saw an uptick in the US services sector, manufacturing input costs reached their highest point since mid-2022. Other economic indicators presented a mixed bag, showing flat output, slightly softer new orders, and firmer employment figures. The overall report carries a marginally hawkish undertone regarding inflation but is unlikely to cause significant market upheaval. Crucially, it confirms the underlying strength and resilience of the US economy compared to its European counterpart.

Global Inflation and Policy Watch

In Japan, core inflation for April eased more than anticipated, registering 1.4% year-over-year against a consensus of 1.7%. This deceleration was significantly influenced by government subsidies for fuel and education. While inflationary pressures have temporarily subsided, a rebound is expected as these temporary measures fade. Despite this, Bank of Japan policymakers are increasingly signaling the possibility of an interest rate hike in June, a notable shift in their long-standing accommodative stance.

The UK's economic landscape is also clouded by uncertainty. Business activity weakened substantially in May, with the flash composite PMI falling to a 13-month low of 48.5. Services activity hit its lowest point since 2021 at 47.9, while the manufacturing PMI showed more resilience. Firms are reporting declining output, rising inflation, supply chain disruptions, and job cuts. This challenging environment leaves the Bank of England in a difficult position, balancing the need to combat inflation with the risk of exacerbating an economic downturn.

Meanwhile, Sweden's Riksbank is expected to maintain its stance of looking past supply shocks, given well-anchored inflation expectations and weak demand. Recent surveys indicate that inflation expectations are falling, with 2-year expectations at 1.9% and 5-year expectations at 2.0% in May.

The Bigger Picture

The European Commission has revised its growth forecasts downwards for the Eurozone, now projecting GDP to increase by only 0.9% in 2026, down from a previous estimate of 1.2%. Inflation (HICP) is expected to remain elevated at 3.0% in 2026, persisting significantly above the 2% target until the third quarter of 2027. These projections align with current market expectations and likely fall within the range of the ECB's upcoming projections.

Norway's central bank is closely monitoring inflation expectations, which have shown signs of re-anchoring. The latest Norges Bank Expectations Survey revealed a rise in CEOs' 12-month inflation expectations to 4.1% from 3.9%. These survey results are a critical gauge for the Norges Bank as it formulates its monetary policy decisions.

Equity markets experienced a volatile session, with global indices nearing or reaching new all-time highs. Macroeconomic data and geopolitical developments, particularly concerning Iran, drove significant intraday price swings. Cyclical stocks generally outperformed, though regional and sector-specific rotations were noteworthy. In Europe, defensive stocks led the market, and a notable underperformance in bank stocks, despite rising rates, suggests investor concern over the stagflationary implications of the weak PMIs and potential ECB rate hikes for reasons deemed unfavorable by equity investors.

This morning, Asian markets are showing gains, with Japan leading the advances, driven by a positive macroeconomic outlook and reopening optimism rather than a typical tech rotation. A similar dynamic is observed in European and US futures, with Europe showing stronger gains ahead of the US, and again, not led by technology stocks.

Market Ripple Effects

The contrasting economic performance between the US and the Eurozone is likely to have significant implications for currency markets. The USD/EUR pair, currently hovering near 1.16, could see continued volatility. While US economic strength supports the dollar, dovish signals from the ECB, driven by weakening growth, might put downward pressure on the euro. Traders will be closely watching incoming wage growth data from the Eurozone for Q1, with expectations for it to remain stable at 2.9% y/y. Any deviation from this could significantly impact ECB policy expectations and the euro's trajectory.

Bond markets are also reacting. In the US, updated forecasts point to two rate hikes by the Federal Reserve towards the end of the year, leading to upward revisions in US interest rate expectations across all horizons. This contrasts with the Eurozone, where softer PMIs are tempering expectations for further ECB rate hikes beyond the anticipated June move. Long-end European swap rates are projected to decline over the next year, though the risk picture suggests a more balanced outlook, limiting the extent of the fall in 10-year EUR swap rates. The attractiveness of long USD/SEK is also being highlighted, suggesting potential for further gains in the US dollar against the Swedish krona.

The Bank of England faces a delicate balancing act. The weakening UK economy, coupled with persistent inflation, creates a challenging environment. Investors will be monitoring upcoming data releases for any signs of a deeper downturn or a more stubborn inflation problem, which could lead to increased volatility in UK assets and sterling.

Finally, the equity market's reaction highlights a key tension. While cyclicals are generally favored, the underperformance of European banks amid weak PMIs suggests a growing concern about stagflation. Investors are wary of rate hikes that might be necessitated by inflation but could further stifle already weak economic growth, creating a complex environment for stock selection.