Dollar in Soggy Start to August as U.S. ISM Data Points to Slowing Inflation

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A key measure of U.S. inflationary developments adds to evidence a peak in inflation is nearing, weighing on the Dollar at the start of August.

ISM prices index dropped to 60 in July from 78.5 in June, the market was looking for a more robust 74.3.

This is the index’s lowest reading since August 2020 and indicates the price pipeline is cooling.

"This is BIG news as it leads the CPI by 4 months," says Andreas Steno Larsen, Director at Heimstaden.

"Prices expansion eased dramatically in July, but instability," says Timothy R. Fiore, Chair of the Institute for Supply Management (ISM).

The July Manufacturing PMI registered 52.8%, down 0.2 percentage point from the reading of 53% in June but ahead of forecasts for 52.0.

The ISM price index is a measure of the cost pressures manufacturers are facing and given these pressures are typically passed on to consumers they offer a guide to where CPI inflation is heading.

The data adds weight to arguments that U.S. inflationary pressures are close to peaking, and with it the Federal Reserve's rate hiking cycle.

While there are further Fed hikes to come, the size and total number of hikes will inevitable be revised lower on any data that suggests inflationary pressures are starting to come down.

Given the Fed's hiking cycle has underpinned the Dollar for months now, any rerating in expectations by the market could weigh on the Dollar going forward.

The ISM price data helps ensure the Dollar's soft start to August continues: the GBP to USD exchange rate is 0.80% higher at 1.2270, the EUR to USD exchange rate is two-thirds of a percent higher at 1.0267.

The Federal Reserve raised interest rates a further 75 basis points last week and said it would now become more data-dependent than it has been in the past, in what amounts to a major departure from its long-held policy of providing forward guidance on policy and rate setting.

In short data matters more than it has done in the past and the emphasis on the ISM price index is therefore consistent with the Fed's latest pivot.

However, last Friday the Bureau of Economic Analysis said its measure of inflation, the Core PCE Price Index, rose 0.6% month-on-month in June, beating the consensus analyst expectation for 0.5% and doubling May's reading of 0.3%.

The index rose 4.8% in the year to June, hotter than the 4.7% the market was looking for and the previous print of 47%.

The PCE matters greatly to Federal Reserve policy as "the inflation objective of the FOMC is set in terms of the rate of change of the price index for total personal consumption expenditures (PCE)," according to the Fed.

But the ISM manufacturing data is arguably telling us where PCE will go in coming months given consumer inflation lags factory gate inflation.

Any further evidence of slowing inflation over coming weeks will add to expectations for the Dollar's current cycle to have peaked.