Market sentiment has slightly shifted against the prevailing notion of policy divergence that had propelled the USD upwards this year. Despite ample evidence of the US economy outperforming its global counterparts, recent business activity data from S&P Global indicates a slowdown, with US activity expanding at its slowest pace in four months in April. Consequently, money markets have adjusted their expectations towards the likelihood of two quarter-point rate cuts by the Federal Reserve (Fed) in the current year, leading to declines in US yields and a broad weakening of the US dollar.
The flash composite Purchasing Managers Index (PMI), which monitors both manufacturing and services sectors, fell to 50.9. While a reading above 50 still signifies expansion in the private sector, it marks the slowest growth since December 2023, suggesting that the US economy may not be as robust as previously believed. Furthermore, the composite measure of orders revealed the first contraction in six months, while employment declined for the first time since June 2020, particularly affecting the services sector. This softening in the labour market has also dampened price pressures, with both input costs and output charges rising at slower rates.
As the USD continues to recoup losses, traders are eyeing Thursday's US GDP report and Friday's March data on the Fed's preferred inflation gauge, the PCE deflator. Should these indicators fall below estimates, it's likely to exert further downward pressure on the USD.
According to recent flash PMI data, the UK economy's recovery from recession unexpectedly accelerated at the beginning of the second quarter. This data preceded relatively hawkish comments on monetary policy from Huw Pill, the chief economist of the Bank of England (BoE). These developments, coupled with weaker US PMI figures, contributed to the largest daily rise (0.8%) of GBP/USD so far this year and saw GBP/EUR surpass its 200-day moving average above €1.16.
The decline in inflation and subsequent strong rebound in consumer real disposable income are driving growth in the UK. The UK composite PMI climbed to a robust 54.0 in April, exceeding expectations and marking the strongest expansion in business activity since May 2023. Notably, the UK has consistently outperformed the US every month this year. The increase was led by a significant upturn in the services index to 54.9 from 53.1, offsetting a downturn in manufacturing to 49.1 from 50.9. Meanwhile, firms reported the slowest rise in prices charged in over three years, yet they also faced the strongest cost pressures in 11 months, particularly from staff wages following the 9.8% minimum wage hike in April. This raises concerns that despite headline inflation nearing the 2% target, the battle against inflation pressures may not be over. Indeed, Mr. Pill highlighted the greater risks of cutting rates too hastily, even as inflation approaches target levels.
