ISM and ADP Better than EXpected, but Can It Really Help the Dollar?

The non-manufacturing ISM surprised to the upside, actually improving over June and this follows on the heels of a somewhat better than expected ADP report. The dollar is finding support in response.

The ISM headline was 54.3 up from 53.8. The consensus had looked for a decline. Of note, the forward looking orders index jumped to 56.7 from 54.4. The employment component rose back above 50 (50.9) from 49.7. This coupled with the ADP report (42k vs consensus of around 30-35k), and a continued decline in Challenger job cuts may see some economists revise up forecasts for Friday's US jobs report.

The dollar is moved higher and is has made new session highs, but the upside is likely to prove still limited. The $1.3140 area corresponds to the euro's 5 day moving average. A break of there could see a return toward Monday's low of $1.3050. Unlike the euro, sterling remains within yesterday's trading range and the 5-day average is further away around $1.5425. The dollar's five day average against the yen comes in near JPY86.30.

On one hand, the stronger data is encouraging a recovery in equities and in the risk appetite, which has in recent weeks done the dollar few favors. On the other hand, there continues to be talk of new QE by the Fed.

Here there may be more than meets the eye. The Federal Reserve typically replaces maturing Treasuries with new purchases. The focus of the QEII talk is on the proceeds of the mortgage bonds that maturing or seeing early pay downs. Recycling that cash back into mortgage bonds is not different in substance from what the Fed typically does with Treasuries and cannot really be considered fresh QE. It simply would maintain existing level of holdings.

With mortgage rates already low, Treasury yields low and the spreads tight, it is not clear what the purpose would be except to maintain the existing size of the Fed's balance sheet and perhaps a psychological support. There would also be a cost.

Most of the dealers quoted in the news wires do not appear in favor. The mortgage bond market is already thin and the number of failed trades has reportedly increased. More Fed buying would arguably add to illiquidity of that market. And with rates low, it is not clear that new purchases would trigger a refi wave.

The risk is that many investors are over-reacting to short-term volatility of macro economic reports. Quantitative easing, or what the Fed has called credit easing, is an emergency mechanism. While the US economy is still strained and restrained by structural impediments, it is hardly an emergency that can be addressed by tweaking the Fed's balance sheet.