U.S Dollar Wakes With a Hangover After 1.8% Decline Mid-Week

"It has been a crushing day of losses for the U.S. dollar.  The greenback shed more 1.7% and in many cases close to 2% of its value against all of the major currencies." - Kathy Lien, BK Asset Management.

"America’s dollar awoke with a severe hangover after enduring its worst day in months on Wednesday," notes Joe Manimbo, analyst with Western Union. "Sharp souring in sentiment knocked the dollar to October lows against the euro and to December lows against the Canadian dollar."

The pound meanwhile managed to advance back above 1.46, a level not seen since the turn of the year.

The U.S Dollar lost significant ground on Wednesday after Non-Manufacturing ISM in January showed larger-than-expected drop to 53.5 from 55.8 in the month before, when less steep decline to 55.1 had been forecast by a Reuter’s poll of 70 economists.

The news follows in the foot-steps of Monday's disappointing Manufactruing PMI, a release that triggered heavy selling after confirming the US economy's growth profile is slowing.

Entering February, a richly priced US dollar was based on the assumption that a forceful US Federal Reserve presented the case for up to four future rate rises in 2016.

US Fed to Ease Back on Rate Rise Agenda

The markets are selling the dollar in the belief that this agressive guidance is not supported by the economic reality.

“One thing I think we can say with more confidence is that financial conditions are considerably tighter than they were at the time of the December meeting. So if those financial conditions were to remain in place by the time we get to the March meeting we would have to take that into consideration in terms of that monetary policy decision," said Bob Dudley, the president of the New York Fed and FOMC member.”

Some argue that it were these words, moreso than the non-manufacturing data, that triggered the USD sell-off. Nevertheless, "when the ISM non-manufacturing numbers printed lower, the dollar tripped stops and shot to new highs versus many of the major currencies," says BK Asset Management's Kathy Lien.

The dollar broke out of long tight ranges in several significant pairs on the back of the news.

The EUR/USD pair, for example, rose to 1.1116 following the news, finally breaking out of a range it had been locked in for weeks between 1.09 and 1.07.

Sterling too capitalised on the weak dollar, running up to 1.4617 after forming a rising wedge ever since basing at the Jan 21, 1.4079 lows.

Components of the Index

The results for the components of the Index were as follows:

Business Activity fell to 53.6, down 5.6 from prev.

New Orders fell 2.6% to 56.5.

Employment dropped 4.2% to 52.1.

Prices Paid fell 4.6% to 46.1, showing a fall for the first time into contraction territory.

RBC Positive About Data

Commenting on the figures, RBC economics said they thought the result was still positive as it remained above 50 and therefore in “expansionary territory”.

The pointed to weather conditions as playing a part in the lower-than-expected result:

“The drop in the ISM non-manufacturing index in January was disappointing and could raise some concern about the domesticeconomic backdrop; however, the measure remained solidly in expansionary territory, and at least part of the dip in January appears to have reflected temporary disruptions from severe snowstorms in the Northeast in the month.” 

RBC go on to argue that they think the ‘fundamental backdrop remains basically solid:

“Strong labour markets to the end of 2015, along with still-low interest rates and strong consumer spending, point to a strong fundamental domestic backdrop.

“We continue to expect that stronger domestic demand growth will be sufficient going forward to offset the negative effect on externally exposed sectors, like manufacturing, of a stronger US dollar and uncertain global demand.

“Our forecast assumes that gross domestic product (GDP) growth will strengthen to a 2.5% rate in the first quarter of 2016 from the 0.7% increase in the fourth quarter of 2015.”

Therefore we can surmise from RBC’s analysis that the negative effect on the dollar was probably exaggerated and likely to be temporary.

Markit Survey also Negative

The report came after separate survey data from Markit showed Services Sector growth also slowing in January.

The data overshadowed ADP Employment news which showed a positive 205k rise in jobs in January and is considered by some as a useful bellwether of how Non-Farm Payrolls will turn out – despite research showing little correlation between the two.