U.S. Dollar Losses Deepen after ISM Services PMI Confirms Economy Hit Speed Bump in December

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- USD weakens after services data shows economy hitting speed bump. 

- ISM services PMI may stoke analyst fears that U.S. economy is faltering.

- But some say this is just a "correction", it's too early to doubt the Fed.

The Dollar wallowed in the red Monday and so-called risk assets remained well supported even after the latest Institute of Supply Management (ISM) PMI showed the outlook for the mighty U.S. services sector cooling in December. 

The ISM non-manufacturing PMI declined from 60.7 to 57.6 in December when markets had looked for it to fall only to 59.6 for the month, taking the index back to its lowest level since July 2018.

Services companies still grew in December, only at a slower pace than was previously the case, as current activity, employment and price growth all moderated during the month. However, and on the upside, new orders bucked the trend and grew by 0.2% at the sector level last month. 

"There wasn't as much drama as in the manufacturing index, but the ISM services survey also pulled back in December. Some will be inclined to see this as a "soft" reading, but it really isn't in absolute terms," says Avery Shenfeld, chief economist at CIBC Capital Markets.

Shenfeld notes that the ISM index is still in the middle of the range tracked since mid-2017 and that it remains at the higher end of the range seen during the years since 2011, suggesting the sector remains in good condition. 

Amongst all of what might yet be written about December's fall in the services index, it remains the case that the PMI had until December spent three consecutive months sat above the 60 threshold, which left it close to a record high and was unprecedented in all prior economic cycles. 

Against that backdrop, an eventual decline was probably all but inevitable, although markets had been waiting with baited breath for the data to be released because of the impact its sister survey of the manufacturing sector had on investor confidence last week. 

The manufacturing survey registered its largest deterioration for nearly a decade, taking the index back to its lowest since the end of 2016, after production and new order growth both fell considerably. 

Many analysts attributed manufacturing's decline to President Donald Trump's so-called trade war against China finally beginning to bite the economy. 

"That's all the more impressive given all the scary headlines that respondents to this survey would have been reading as they filled it out. Little market reaction is likely, as the miss vs. consensus wasn't that large for this indicator," Shenfeld says, of Monday's survey. 

PMI surveys measure changes in industry activity by asking respondents to rate conditions for employment, production, new orders, prices, deliveries and inventories. A number above the 50.0 level indicates industry expansion while a number below is consistent with contraction.

Markets care about the data because it is an indicator of momentum within the economy and economic growth has a direct bearing on consumer price pressures, which dictate where interest rates will go next.

"In one line: This is a correction, nothing more," says Ian Shepherdson, chief U.S. economist at Pantheon Macroeconomics, of the services data. "The index usually tracks the rate of growth of core retail sales but has been relatively elevated since Hurricane Florence in September—it also overshot after Hurricane Harvey in September 2017—so a correction was due, but the timing and extent was uncertain."

Shepherdson says the services index is now about 1% lower than he would have expected given the recent pace of retail sales growth but that this discrapancy is within the margin of error and fundamentals of the services sector are much more sound than those of manufacturing.

The U.S. Dollar index was quoted -0.52% lower at 95.72 following the release Monday after extending an earlier -0.38% loss. It is now down -0.31% for 2019, after having risen around 5% last year.

Losses were broad-based, with the Dollar declining against all G10 currencies at the start of the week. The Pound-to-Dollar rate was 0.59% higher at 1.2778 while the Euro-to-Dollar rate was up 0.59% at 1.1460. 

Recent commentary from the Federal Reserve (Fed), political events in Washington, December's PMI surveys and the ongoing "trade war" between the U.S. and China have seen financial markets about-turn on their expectations for U.S. interest rates in 2019 over recent weeks.

This has dented the Dollar but not all economists are ready to call time on the U.S. economic expansion, much less the raucious upturn seen by the services sector over the last couple of years.  

"The low coincided with the very month the oil price was bottoming out below 30 dollars per barrel. More indicative of a US slowdown would be a weakISM Non-manufacturing survey, which represents the dominant services sectors of the US economy and over the last quarter has registered an unprecedented three months in a row above 60," says John Hardy, chief FX strategist at Saxo Bank. "A bit too early to price in a Fed reversal, in other words."

Until December 2018 markets were busy contemplating whether the Federal Reserve would raise its interest rate twice, or on three separate occassions in 2019, but since then pricing in derivative markets has shown investors increasingly contemplating the odds of a rate cut. 

The market implied odds of a Fed rate cut before the end of 2019 have risen to 50% since the beginning of December and derivatives markets currently seem pretty sure that rates will have been slashed by not later than the end of 2020. 

The Fed raised its interest rate range to 2.25% and 2.5% in December but flagged global economic and financial market developments as a growing threat to the U.S. economy.

December's policy update gave a clear indication that U.S. interest rates will now rise at a slower pace in 2019 than policymakers had previously intended, while also making those hikes doubly contingent on incoming economic data. 

The Dollar index rose around 5% in 2018 after reversing what was once a 4% loss wracked up mostly during the first quarter, with a superior performance from the U.S. economy behind the move. That enabled the Federal Reserve to go on raising its interest rate as economies elsewhere slowed and the respective central banks sat on their hands.


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