Dollar Unfazed by U.S. Slowdown Focus on a Worldwide Slowdown

The Dollar rebounded this afternoon against the EUR and GBP following initial weakness on poor economic news. The U.S. ISM non-manufacturing business activity index fell to 41.9 in January from 54.4. This was sharply below pre-release estimates of 53.0. This was the worst reading since the aftermath of the September 11, 2001, terrorist attacks. The magnitude of the break is a sure sign of contraction in the non-manufacturing sector.
While this type of news would have recently sent the U.S. into a tailspin, the market remained relatively unchanged to bearish immediately after the release. Some attribute the mild reaction to the weak PMI index on Euro Zone services released earlier in the day. The final estimate of this number was revised to the weakest level in four and a half years to 50.6.
Today's reports can be interpreted twofold. While the weak U.S. ISM is another confirmation of a looming recession, the Euro Zone services figure is a sign that the U.S. economy is not alone in this slowdown. The poor showing in the U.S. ISM index is also a sign that the FED will continue its easing policy. May Fed Funds futures are implying a 96% chance that the FED will lower its target for overnight rates by a total of 75 basis points to 2.25% after the next two policy setting meetings in March and April. Tomorrow's focus will remain on U.S. economic data as the Fourth Quarter Preliminary Productivity figures will be released at 8:30 EST. Although the next FED meeting is not until March 18, Chairman Bernanke's willingness to act when deemed necessary might prompt the expected cut earlier.
In AUD news, the RBA raised rates by % to 7%, as expected. Following an initial bump against the U.S., the market failed to hold yesterday's gains and broke lower. In its official statement, the RBA said, "In the short term, inflation is likely to remain relatively high and will probably rise further in year-ended terms, though the Bank expects it to moderate somewhat next year." Australian rates remain among the highest of the major currencies. While key central banks have been aggressively cutting rates, the RBA has been steadily raising rates. The trading action today indicates, however, that this could be the last of the hikes. In addition, late chatter that the hike may be as much as 50 basis points may have caused the sell-off.
On Thursday, Feb. 7, the Bank of England (BoE) and the European Central Bank (ECB) are both set to make interest rate announcements. The BoE is expected to cut rates by % to 5.25%. Slowing in retail and manufacturing sectors are prompting this anticipated cut although talk circulated that BoE may decline to soften rates over impending inflation concerns. The ECB is expected to hold rates steady even in the face of softening growth. The market is expecting growth rates to diminish throughout the year as the US economy teeters on the brink of a recession. Watch for market talk today of a possible rate cut in the wake of the weak PMI Index on Euro Zone services
The sell-off in the EUR against the Dollar could be a sign that traders feel that the impending economic slowdown will be global in nature. Dollar bears remained on the sidelines as both the GBP and EUR sold off throughout the day. Traders will be watching U.S. economic data with caution as well as European economic releases for signs of weakness across the board. The USD rally is an indication that traders are willing to let monetary policy do its work on the U.S. economy.
Sharp declines in the U.S. equities markets forced traders to aggressively buy Dollars against the JPY and CHF. There is still some talk of a BOJ rate cut to curtail any bullish interest in the JPY.
This week's U.S. reports include Fourth Quarter Preliminary Productivity (2/6, 8:30 EST), December Pending Home Sales (2/7, 10:00 EST), December Consumer Credit (2/7, 15:00 EST) and December Wholesale Inventories (2/8, 10:00 EST). .