U.S. Dollar Retreats As Manufacturing PMI Drops To New Lows

Key Insights

• The U.S. Manufacturing PMI report confirms that the U.S. economy is slowing down. 
• Treasury yields remain under pressure, which is bearish for the American currency. 
• If the U.S. Dollar Index moves below the 50 EMA at 105.20, it will gain additional downside momentum. 

U.S. Manufacturing Activity Slows Down

The U.S. Dollar Index gained downside momentum after the U.S. reported that Manufacturing PMI declined from 52.7 in June to 52.2 in July, compared to analyst consensus of 52.3. Numbers above 50 show expansion.

The yield of 10-year Treasuries continued to slide after the release of the report. Currently, the yield of 10-year Treasuries is trying to settle below the 2.60% level.

Traders bet that the Fed will be forced to be less hawkish in order to deal with the slowdown in the economy. Importantly, oil prices are also moving lower, which will have a cooling impact on inflation. Lower Treasury yields and the visible slowdown of the U.S. economy serve as bearish catalysts for the American currency.

What’s Next For The U.S. Dollar?

The U.S. dollar will remain sensitive to economic reports in the upcoming weeks. In case oil prices continue to fall, the focus will shift from inflation to the slowdown of the economy. In fact, the U.S. is already in a technical recession, as GDP declined in two quarters in a row.

The Fed is in an uncomfortable situation as inflation stays high while the economy may need support in the upcoming months. The Fed cannot abandon its fight against inflation even if oil prices move lower as it will risk triggering another wave of higher prices.

At the same time, it is clear that the Fed can no longer afford aggressive rate hikes. Most likely, the Fed will also have to adjust the schedule of sales from its balance sheet.

The key question is how the Fed will solve this puzzle. Currently, the markets price in a 71.5% probability of a 50 bps rate hike at the next meeting in September, followed by a 25 bps rate hike in November.

This scenario is somewhat bearish for the U.S. dollar, which has gained a lot of ground against a broad basket of currencies this year. In case the U.S. Dollar Index declines below the 50 EMA at 105.20, it will have a good chance to gain additional downside momentum.

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