Updated at 10:25 am ET

MARKET REACTION

Immediately after the PMI survey crossed the wires, the U.S. dollar, measured by the DXY index, accelerated its daily decline, with Treasury yields initially moving lower. The rapid slowdown in U.S. economic activity, coupled with signs that inflation may be starting to ease, could lead the Fed to adopt a less aggressive stance later this year, a scenario that could reduce the greenback's appeal. While today's data may not change the near-term outlook for monetary policy, expectations for 2023 are gradually becoming less hawkish.

US DOLLAR CHART (1-MINUTE)

Original Post at 10:02 am ET

U.S. economic activity unexpectedly contracted this month according to a preliminary purchasing managers’ survey compiled by S&P Global, a sign that the outlook is rapidly deteriorating on the back of elevated inflationary pressures and weakening demand for goods and services.

According to the financial information and analytics company, its headline Flash Composite PMI, which tracks business trends in both the manufacturing and services sectors, shrank for the first time since the coronavirus-induced lockdowns, falling to 47.5 in July, well below consensus forecasts of 52.1. For context, any figure above 50 indicates expansion, while readings below that level indicate contraction.

Disappointing data on the macro front is likely to heighten fears that the broader economy is headed for a hard landing amid tightening financial conditions, triggered in part by the Federal Reserve's aggressive hiking cycle aimed at restoring price stability. Increased uncertainty, in turn, may fuel greater market volatility in the short term, despite the fact that summer is typically a quieter period.

Looking at the survey’s components, manufacturing PMI slumped to 52.3 from 52.7 previously, registering the weakest upturn in two years, dragged down by a decline in new orders.

Meanwhile, activity in the services sector, where most Americans work, plunged to 47.00 from 52.7, hitting its lowest level in 26 months, with sky-high inflation and soft demand weighing on new sales. This result does not bode well for the outlook and may set the scene for an economic contraction in the third quarter considering that the services sector account for roughly 70% of GDP.

DailyFX Economic Calendar

On the price front, cost burdens remained elevated, but the pace of increases eased from May's peak, indicating that there could be a respite from inflation on the horizon. This hypothetical scenario that may give the Fed an opening to shift to a less hawkish monetary policy stance later this year, especially if the growth profile continues to deteriorate. A “Fed pivot” could be a decisive inflection point for risk assets, setting the stage for a sustainable recovery in US equities.

Taken together, today's horrible report raises the likelihood of a recession in the medium term. True, the strength of the labor market has offset some of the worst fears about an impending downturn, but it is important to remember that employment indicators are lagging barometers of business activity that react late to new developments, meaning they could be giving traders and investors the wrong signals.

More By This Author: