Dollar Shrugs at a Bumper ISM in Sign Good Data is Losing its Impact

- USD slips in risk-on trading despite strong ISM services industry PMI.

- ISM services PMI rises to 58.5, highlighting robust US outlook.  

- But next "trade war" salvo looms, to support USD from hereon.

© kasto, Adobe Stock

The Dollar is mixed ahead of the weekend having failed to catch a bid from a bumper ISM services report, a sign that the currency is becoming increasingly immune to good news on the economy. 

Thursday's ISM services PMI surprised on the upside for August. The ISM non-manufacturing index, a broad measure of activity in the US services sector, rose to 58.5 in August. This is up from the 55.7 level seen back in July and substantially ahead of the consensus for an index reading of 56.8.

The reaction suggests the Dollar has become so used to strong data that they no longer have an impact on the market. Another implication of this is that the currency could react strongly to any future disappointments. And with the US ecnomic cylce burning hot, a slowdown in the tempo of data looks inevitable.

Some say this is a key barrier to the Dollar's 2018 rally extending into 2019.

"Fading positive US data surprises, extreme long USD positioning (see chart above) means that we think the broad dollar index has most likely put in a short-term cyclical top now," says Viraj Patel at ING Group.

The Institute for Supply Management said most respondents to its survey remain upbeat about the business outlook, with 16 non-manufacturing industries reporting growth in August, although many have noted that a tight labour market and President Donald Trump's tariffs on a range of imported goods are beginning to push up operating costs.

"The 58.5 reading, up from 55.7 the prior month, isn't quite as lofty as what we saw in the factory ISM, but is still a bit above the 6 month moving average for the series. Separately, factory orders were -0.8% in July, after a 0.6% prior month gain, a result that matched our call but was a bit weaker than consensus," says Avery Shenfeld, chief economist at CIBC Capital Markets. "All told, a mixed bag of news today, but nothing that will alter expectations for a decent Q3 growth rate (we are at 3.0%) and a Fed hike at the next FOMC."

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.

"On past form, a weighted average of the ISM surveys is now consistent with economic growth in excess of 5% annualised, from 4.2% in the second quarter. We doubt that economic growth will be that strong, especially since the alternative Markit PMI has been far more downbeat, pointing to growth of just 2.5% annualised. Our forecast for third quarter GDP growth remains 3.0-3.5%, which would still be well above trend and enough to keep the Fed raising interest rates gradually," says Michael Pearce, an economist at Capital Economics. 

Watch Dollar's Reaction to Ongoing Trade Dispute

The Dollar's failure to repsond to the ISM data is also a function of investors appearing to rediscover their collective appetite for risk despite a looming decision from the White House on whether impose more tariffs on goods imported from China.

Stock markets, risk currencies and commodities like oil were mostly higher in European session Thursday while the Dollar was down against most of its rivals, with no clear catalyst for the shift, which comes as markets await the next move in the US-China "trade war". 

"USD should retain support today, with the solid August ISM non-manfacturing being positive for the dollar. Bar the economic side, the US public consultation period on the effect of Chinese tariffs ends today which brings back a risk of a more meaningful escalation of trade wars," says Petr Krpata, chief EMEA strategist at ING Group. 

Markets normally care about the ISM PMIs because they are an important indicator of momentum within the economy. Economic growth has a direct bearing on the rate of inflation and it is consumer price pressures that dictate where interest rates will go next.

US inflation has risen above the 2% target of the Federal Reserve, to 2.9% in July, while the consumer price index sat at 2.4% after volatile food and energy costs are excluded from the goods basket.

The Federal Reserve has raised interest rates seven times since the end of 2015 in order to keep inflation pressures at bay, with two increases so far in 2018.

This and superior US growth, set against a downbeat outlook for interest rates in many other parts of the developed world, has been a material factor behind the US Dollar's outperformance since April.  

"The combination of persistent trade tensions and solid stream of US data has served the USD well and seems set to continue. However the uptrend is more likely to resemble the wide choppy ranges of Q3 rather than the smooth appreciation profile of Q2 given: 1) markets already price almost two Fed hikes by Dec-2018 and; 2) positioning is long USD," says Richard Franulovich, head of currency strategy at Westpac. 

Thursday's ISM data comes alongside the September 06 deadline for the submission of public comments on President Donald Trump's proposal to levy new tariffs on $200 billion of imports from China.

These tariffs will cover a far larger amount of Chinese exports to the US than the original $50 billion and have been billed as a potential watershed moment in the so called Trade war" between the world's two largest economies.

"It has become increasingly obvious in recent months those tariffs will be imposed. The only real question now is when it will happen," says Andrew Hunter, another economist at Capital Economics, in a note Wednesday.

The White House has come to blows with China this year over what it says is the country's failure to address concerns over "unfair trading practices" that include "forced technology transfer and intellectual property theft".

China has retaliated against the US tariffs with levies of its own, on $50 billion of US goods so far, and has threatened to target another $60 billion if the US goes ahead with the larger round of tariffs.

"The administration should announce a new round of tariffs after the public comment period ends this week although it is unclear how quickly that will happen or whether they will adopt a 10% or 25% tariff rate. Rhetoric and political considerations suggest little scope for meaningful conciliatory gestures on either side. The administration will be emboldened by resilient US markets and continuing strong growth," says Westpac's Franulovich.

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