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Dollar Remains Dominant, Adds to Gains over Pound, after ISM Services PMI Shoots Higher

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- USD remains top dog in FX after ISM services PMI shoots higher. 

- ISM scores fourth best on record amid recovery from Gov shutdown.

- U.S economy and USD still best out of an ugly bunch thus far in 2019.

The Dollar added to gains over the British Pound and other currencies in a risk-off market Tuesday after the Institute of Supply Management (ISM) services PMI shot higher for the month of February, taking the market by surprise.

The ISM non-manufacturing PMI rose to 59.7 last month, up from 56.7 previously, when consensus had looked for an increase to only 57.4. The less influential IHS Markit services PMI was simultaneously revised down from 56.2 to 56.0 for that month.

ISM's new orders sub-index for the services industry rose by 7.5 percentage points to 65.2 during the recent month, while current activity levels picked up by 5 points to 64.7, although the employment index dipped by 2.7 percentage points to 55.2. Services prices rose 5 percentage points during the month, suggesting inflation pressures are gaining momentum in the sector.

"The government shutdown had ended, and that may have been behind a surprisingly strong climb in the ISM non manufacturing survey in February. Whatever the reason, the 59.7 reading was more than two big figures above consensus, and is the fourth best level in this survey's history dating back to 2009," says Avery Shenfeld, chief economist at CIBC Capital Markets

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 almost always dictate where interest rates will go next.

"The consensus was very timid; the index clearly was depressed by the government shutdown and the stock price drop in Q4, so a solid rebound was always a good bet.  The reported plunge in December retail sales might have made some forecasters hold back, but we don’t believe the numbers and expect them to be revised up substantially," says Ian Shepherdson, chief U.S. economist at Pantheon Macroeconomics

Above: Pound-to-Dollar rate shown at daily intervals.

The Pound-to-Dollar rate was -0.43% lower at 1.3119 following the release after adding fractionally to an earlier -0.41% loss, while the Euro-to-Dollar rate also slipped further into negative territory. It was -0.30% lower at 1.1302 after extending an earlier -0.03% loss.

The U.S. Dollar index was quoted 0.24% higher at 96.87 following the release, after building on an earlier 0.14% gain, and is now up by 0.90% for the 2019 year-to-date. The Dollar was higher against all G10 rivals Tuesday other than the Swedish Krona.

Above: U.S. Dollar index shown at daily intervals.

Price action and the surveys come in what is a risk-off market Tuesday after the Chinese government said the world's second largest economy could grow at what would be its slowest pace for nearly three decades this year, owing the after effects of the trade war with the U.S. and structural economic deficiencies. 

"Though the result is largely as expected, the first thing that strikes us is the wide 50bp range.  In other words, if the top end of the range is missed by a big amount, policy makers could still appear as if they’re “on target”," says Stephen Gallo, European head of FX strategy at BMO Capital Markets.

Chinese officials say GDP could grow by as little as 6% this year, and is unlikely to expand by any more than 6.5%, which would be the slowest expansion since the early 1990's if only the lower end of the forecast bracket is achieved. 

And that's after the government pumps up the economy with fiscal stimulus it estimates to be worth around 2.2% of GDP. In other words, China's economy is in trouble even if the nation's leadership is succesful in ending the tariff fight with the U.S. that has roiled global markets these last 12 months.

"A set of pro-growth measures are planned despite positive progress in US-China trade talks, which makes us think that either China doesn't have full confidence in a trade truce or that the damages from the trade conflict cannot easily be undone," says Iris Pang, a Greater China economist at ING

Above: U.S. Dollar vs Chinese offshore Renmimbi/Yuan.

Investors are watching economic data, and central bank responses, on both sides of the Atlantic Ocean closely for signs of another downward lurch in economic growth rates and therefore - interest rate expectations. 

Many investors and most analysts entered the 2019 year forecasting a capitulation by and steep losses for the U.S. Dollar in 2019, based on the idea the international interest rate tables would turn against the greenback.

Their thesis was that growth would soon pick back up in Europe after a second-half lull last year, and that the "sugar high" from President Donald Trump's tax cuts would wear off this year, leaving the U.S economy in the cold. 

That should have been enough to see the Federal Reserve (Fed) end its interest rate hiking cycle at a time when the European Central Bank (ECB) and its counterparts elsewhere on the old continent were gearing up to begin lifting rates themselves. 

Above: Bloomberg Dollar index shown at daily intervals. Source: BMO Capital Markets.

"It’s interesting to us that the EUR and the CAD are amongst the worst-performing G10 currencies vs the USD since the close last Friday.  Importantly, their respective central banks both have rate decisions this weekk," BMO's Gallo writes, to clients on Tuesday. "It is astounding to us that the BBDXY still managed to rally 0.77% in February.  We cannot emphasize this enough: this dynamic speaks volumes."

But so far at least, things have not worked out quite like consensus had imagined just a couple of months ago. Granted, the Fed has come close to ending its rate hiking cycle, although not because of a slowdown in the U.S. economy, but rather weakness in China, Europe and elsewhere. 

Moreover, the economic slowdown that began in Europe late last year appeared to spill over into 2019, with manufacturing sectors in the bloc's core economies hit the hardest. And the currency union still faces a range of headwinds that could yet further undermines growth later in the year, including Brexit and a EU parliament elections. 

"Our opinion is that, on the basis of ECB policy alone, the EUR is still cornered on the downside. Barring a major positive development at the global level (which we won’t completely rule out), the ECB is either going to turn more assertively “dovish” at some point or it’s not; in either scenario, you don’t really want to be buying EURs," Gallo says. 


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