US: Positive ISM report gives way to risk aversion – MUFG

Derek Halpenny, European Head of GMR at MUFG, notes that there was a notable turnaround for the dollar in afternoon trading yesterday in London that is certainly worth highlighting given it may indicate a less certain path for the dollar at more elevated levels going forward.

Key Quotes 

“The dollar was looking a little stretched versus some key currencies like the yen which makes the turnaround for the dollar after strong US data all the more interesting.”

“Firstly the data – the ISM Manufacturing report was certainly impressive and helps cement the view that sentiment both on the consumer side and business side has had a notable lift that point to positive momentum for the economy as we enter 2017. All the key components in the ISM report increased with production and new orders jumping notably. As can be seen below, the new orders one-month gain was the largest since August 2009. But export orders also jumped significantly to a level (56.0) not seen since May 2014 suggesting that at least initially the surge of the dollar has not dented the outlook for exports.”

“But secondly the market response – following an initial leg higher for the dollar after the ISM report, the dollar reversed course with USD/JPY falling from 118.60 to 117.60; basically unchanged on the day while the DXY index fell from 103.80 to 103.00. US equities slid by close to 1% from intra-day highs.”

“The turnaround coincided to some degree (equity selling had already begun) with the announcement by Ford to cancel plans for a new production plant in Mexico and immediately prompted a degree of risk aversion, highlighted by the equity market sell-off and the reversal of yen and euro weakness. The Mexican peso also tumbled.”

“But the financial markets appear confused as to how to read news such as that announced by Ford (US equities did recover). Ford was planning a USD 1.6bn investment in the new plant in Mexico. Instead Ford will use existing production capacity in Mexico and will shift Ford Focus production there but with the estimated USD 700mn of savings will invest in retooling a current plant in Michigan for production of electrified SUVs. The move will create 700 new jobs in Michigan. Without delving too deeply we can conclude that Ford’s decision is good for the US economy and bad for Mexico’s.”

“But there are a whole host of ifs and buts. A surging US dollar and rising wages will put an increasing onus on the removal of regulatory red tape and the implementation of corporate tax cuts that Trump has promised in order to fuel business investment to lift productivity to ensure competitiveness is maintained or restored. Only time will tell on that. Will Ford’s actions be followed by other US automakers and other corporations in general? For now though, the correction weaker for the US dollar on this news has been modest and we assume at this stage that market participants will focus on the positive economic benefits. That suggests continued positive sentiment for the dollar. However, the correction weaker for the dollar yesterday should serve as a reminder that Trump’s approach to economic policy may well lead to increased FX volatility, especially as the value of the dollar becomes more elevated.”