Recession fears are back! The US dollar traded sharply lower after the ISM manufacturing report fell to its weakest level in more than 3 years. Manufacturing is an important part of the economy and one of the first to feel the effects of slower global growth. Manufacturing activity contracted for the first time since August 2016 as exports declined and new orders fell to a 7-year low. August was also the fifth straight month of weaker activity. The service sector represents a larger part of the economy but services won’t be able to grow if manufacturing keeps contracting. In response to the disappointing report, Treasury yields dropped to fresh 2 year lows while the Dow Jones Industrial Average lost more than 300 points. USD/JPY closed below 106 and EUR/USD rallied for the first time in 7 trading days. This deterioration in the manufacturing sector will make it difficult for the Federal Reserve to maintain a positive bias. We expect a cautious Beige Book tomorrow and look for the trade deficit to grow which should extend the losses for USD/JPY towards 105.

The only currency that performed worse than the US dollar today was the Canadian dollar. Investors are reluctant to buy loonies ahead of the Bank of Canada’s monetary policy announcement. USD/CAD is hovering near 5-month highs and could hit 1.34 if the central bank suggests that they could lower interest rates in October. The Bank of Canada has been sitting comfortably on the sidelines but the market is pricing in 75% chance of a rate cut before the end of the year. Data from Canada hasn’t been terrible but we are beginning to see signs of weakness. Retail sales stagnated in the month of July but ex-autos spending was strong. Labor market conditions weakened but this week’s employment report should show an improvement. Inflation hovers around the central bank’s target and manufacturing activity is steady. With that said, a lot has changed since their policy meeting in July and Canada is not immune to US and China troubles. Expectations are building for a dovish BoC statement this week and if the BoC hints of a rate cut, USD/CAD will break out of its 3-week long-range and make a run for 1.34. However, if they keep their outlook unchanged, the relative strength of Canada’s economy compared to the rest of the world should drive USD/CAD below 1.32.

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The Australian dollar was the day’s best performer. Although retail sales took an unexpected dip in July, the current account surplus hit its highest level in 44 years as the Reserve Bank made it clear that despite China’s troubles they are in no rush to ease again. Exports, in particular, were very strong and will add 0.6% to tonight’s second-quarter GDP report. It is data like this that makes the central bank confident that “growth will strengthen gradually to around trend”. The RBA said they will ease further if needed but in the same statement, they highlighted the recovery in the housing market and indicated that stability in housing will support spending. They are also seeing a little upward pressure on wage growth, which eases their concerns about low inflation. From a fundamental and technical perspective, we could be witnessing a near term bottom in AUD/USD. With the pair ending the NY session at its highs, a stronger move above 68 cents is likely.

Meanwhile, EUR/USD snapped a 6-day losing streak. Its stability was driven entirely by anti-dollar flows but that could change tomorrow with revisions to EZ PMIs and Eurozone retail sales scheduled for release. Consumer spending in Germany fell sharply in July and this weakness is expected to carry over to the regional report. The greatest volatility today was in sterling, which dropped below 1.20 on reports that Parliament could call early elections. However, the pair turned higher after defections from the Tory party caused the government to lost its working majority in the House of Commons. This could force Boris Johnson to go to the EU and request a 3-month delay until January 31st, which thee market perceives positively.