US Dollar Rises after ISM Manufacturing PMI Shows US Economy Widening Lead Over Rest of World

-ISM Manufacturing index beats expectations in June, rises to 60.2.

-US economy has furthered its lead over the rest of world economy.

-But capacity constraints and tariffs are now starting to bite the sector.

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The US Dollar strengthened during noon trading Monday after the latest ISM Manufacturing PMI survey suggested the US widened its lead over the rest-of-world economy during June, refocusing the market's attention back on divergence between monetary policies across the world's largest economies.

The ISM Manufacturing index rose to 60.2 for the month of June, up from 58.7 previously, when economists had looked for it to ease back to 58.2. The ISM report comes hard on the heels of IHS Markit data released Monday that confirmed a sharp slowdown in Europe's manufacturing sector during the first six months of the year.

US production rose by 0.8% during the month but new orders dipped 0.2% and employment slipped 0.3%. The supplier deliveries index rose 6.2% as deliveries slowed at a faster pace and order backlogs rose, signalling increasingly apparent capacity constraints in a sector that has seen the ISM PMI remain close to a decade high for 14 consecutive months now.

"The increase in the ISM manufacturing index in June is a clear sign that, for now at least, the strength of the domestic economy is more than offsetting any increased uncertainty on trade policy. However, with the dollar appreciating by 6% since April, global growth slowing and retaliatory tariffs just beginning to bite, the sector looks unlikely to fare so well for long," says Michael Pearce, a senior US economist at Capital Economics. "The report provided plenty of anecdotal evidence that tariffs were beginning to disrupt production and were pushing up input prices."

Markets care about the data because changes in manufacturing activity provide insight into real world demand for the US Dollar, given the US economy is also a large exporter as well as consumer of goods, in addition to a steer on the trajectory of overall demand within an economy. US households have benefited from an increase in their disposable incomes this year after one of the largest programmes of tax cuts and reforms in American history, supporting consumer spending.

The US Dollar index was quoted 0.57% higher at 95.12 during the noon session Monday after the greenback notched up gains over the entire developed world currency basket. The Pound-to-Dollar rate was 0.57% lower at 1.3119 while the Euro-to-Dollar rate was 0.72% lower at 1.1595.

Despite the robust data for June the US manufacturing sector, as well as broader economy, will be challenged in the months ahead by the effects of a strengthening currency and President Donald Trump's so called "trade war" with China and the European Union. The Dollar converted a 4% 2018 loss into a 2.8% profit during the two months since the middle of April.

Most analysts now agree that superior levels of US economic growth have bolstered the case for the Federal Reserve to keep raising its interest rate, at a time when the interest rate outlook elsewhere in the world is deteriorating, which has incentivised traders into selling other developed world currencies and buying US Dollars. However, those arguing for further US Dollar gains are increasingly being challenged by President Donald Trump's trade policies. 

"With the new orders index little changed and production up only 0.8 points, the headline index was driven by a 6.2-point jump in supplier delivery times to 68.2, the highest since May 2004. The ISM blames a combination of "steel and aluminum supply disruptions, supplier labor issues, and transportation difficulties"," says Ian Shepherdson, chief US economist at Pantheon Macroeconomics. 

President Trump has been pursuing restrictive legislation to govern Chinese investments into the United States and recently ordered that a range of tariffs be levied against imports of more than $250 billion in American imports of Chinese goods. The latest levies come into force on July 06. He has also levied new tariffs on all imports of steel and aluminium from China, Canada, Mexico and the European Union.

The White House has also been attempting to reduce the US trade deficit, citing it as a sign of malpractice by other countries in the international trade arena and evidence that protectionist action is needed by the White House.

The moves so far have drawn retaliation and threats of even further reciprocal measures from the Chinese, which all comes on top of earlier White House tariffs on imports of steel and aluminium into the United States from across the globe, including the European Union. The EU has since responded with its own levies on US motorcycles, jeans and whiskey, drawing threats of even more tariffs from the White House, this time targeting the mighty European automotive sector.

Fears are that a tit-for-tat tariff fight between the world's largest economies will quickly descend into an all out "trade war" and that this will dent economic growth in all countries it touches, which could stymy the Federal Reserve from raising its interest rate further while also denting the odds that other central banks will be able to raise their rates any time soon. 

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