US Dollar Softens After Weak US Business Activity Data Raises Recession Odds

US PMI KEY POINTS:

• US Composite PMI drops to 51.2 in June from 53.6 in May, hitting a five-month low
• Flash Services Business activity at 51.6 from 53.4 prior, also a five-month low. Meanwhile, Manufacturing PMI sinks to 52.4 from 57 one month ago, its worst reading in 23 months.
• Anemic growth suggests the U.S. economy failed to rebound meaningfully during the second quarter and that a recession could be around the corner

Most Read: EUR/USD Tanks as Shocking PMIs Signal Rising Recession Risks

U.S. economic activity continued to decelerate at the tail end of the second quarter, weighed down by sky-high price pressures and weakening demand conditions. According to S&P Global, its Flash Composite Purchasing Managers’ Index, which combines manufacturing and services production data, dropped to 51.2 in June from 53.6 last month, reaching its lowest mark since the start of the year when the omicron variant brought the recovery to a screeching halt. Any figure above 50 signals expansion while readings below that level indicate contraction.

Looking at the internals, the services PMI fell to 51.6 from 53.4 in May, disappointing expectations that had called for a modest increase to 53.5. Manufacturing PMI, for its part, sank to a 23-month low of 52.4 from 57, well below consensus forecasts (see below).

DAILYFX ECONOMIC CALENDAR

Source: DailyFX Calendar

Although both the manufacturing and services sectors managed to grow this month, the pace of expansion slowed dramatically, raising serious concerns about the health of the economy and the possibility of a recession in the medium term.

The U.S. dollar, measured by the DXY index, erased gains and briefly slipped into territory after the S&P Global Purchasing Managers’ Index data crossed the wires, deepening its decline of recent days. This reversal has coincided with a pullback in U.S. Treasury rates, with the 2-year yield and 10-year yield trading at 2.95% and 3.04% respectfully, off by about 50 basis points from their cycle’s high last week.

Although expectations may change, yields have repriced lower on worries that the U.S. economy may be headed for a downturn amid tightening financial conditions.The Fed waited too long to begin removing accommodation to address rampant inflation and is now trying to front-load rate hikes in the most aggressive moves since Paul Volcker led the bank in the 1980s, raising the likelihood of a self-induced crisis.

US DOLLAR REACTION

Source: TradingView

Concern has increased after Fed Chairman Powell acknowledged that the FOMC‘s powerful actions could trigger a recession, saying such a scenario is possible and characterizing a soft landing as “very challenging” in the current environment. It then comes as no surprise that the market has started to scale back bets on future monetary tightening. For example, traders now price a terminal rate of 3.41% for next year according to Fed funds futures, down from 4.15% one week ago, a 74 bp reversal in less than 10 days.

Fed Funds Futures Implied Rate (May 2023)

Source: TradingView

Today’s PMI reports confirms that U.S. economic activity is decelerating rapidly. This situation could prompt investors to wager that the Fed will blink and won’t deliver on its promise to lift borrowing costs forcefully beyond 2022, paving the way for U.S. yields to move lower. This scenario could undermine the U.S. dollar in the months ahead provided that panic and extreme risk-off sentiment don’t break out in financial markets.

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—Written by Diego Colman, Market Strategist for DailyFX