The Slowing ISM Manufacturing PMI and What It Means for the Greenback

Since the Fed‘s interest rate decision, the ISM manufacturing PMI has been the most important release from the U.S. It is widely considered to be one of, if not the premiere leading indicators of the U.S. economy.

That’s why it wasn’t much of a surprise to see investors panic following yesterday’s dismal report. The PMI came in at 49.7, which is lower than both May’s reading of 53.5 and the market’s forecast of 52.1.

ism-manufacturing-index-report-card.pngAlthough it wasn’t the first time that the ISM manufacturing PMI fell short of expectations, it was the first time since August 2009 that the report printed below 50.0.

The 50.0 level is very important because it determines if the manufacturing sector is expanding or contracting. Anything below 50.0 is interpreted as recessionary.

Digging deeper into the report, I found out that prices paid for raw goods fell drastically from 47.5 in May to 37.0 in June. This is bad news since the drop is indicative of deflation.

Considering that the Fed is already worried of slowing inflation, signs of deflation may just upset central bankers even further!

New orders also took a beating last month as the component crashed from 60.1 to 47.8. Factory orders are often considered a leading indicator of overall economic momentum since purchase orders imply that manufacturers will have to increase their production.

And finally, just like May’s non-farm payrolls, the employment component was bleak. The reading for employment went to 56.6, down from 56.9.

What does the PMI mean for the economy and the Greenback?

While the disappointing PMI doesn’t necessarily lead to contraction, it does leave the U.S. economy open to it. As more and more weak data comes in–and as euro zone‘s problems are far from being resolved–investors are starting to price in the possibly of another U.S. recession.

Given the fragility of the U.S. economy, and the rising deflation concerns due to the weak prices component of the ISM manufacturing PMI, the “maybe” of the Fed with regards to QE3 is now a “highly likely.”

For the Greenback, this is obviously negative. In the last two occasions leading up to quantitative easing, the Greenback was sold-off heavily. It’s reasonable to expect the same thing to happen again.