ISM Manufacturing PMI Preview: Low expectations in three figures open door to dollar upswing

• Economists expect the ISM Manufacturing PMI and its key components to have dropped in December. 
• Downbeat estimates lower the bar for upside surprises.
• The dollar has room to gain ground in response to the first top-tier release in 2022.

The year only begins in earnest when everybody is back from vacation – and with a release of a top-tier indicator. Traders are fully back only on Tuesday, January 4, and a significant publication awaits them – the ISM Manufacturing Purchasing Managers' Index. That is set to rock energetic markets after the holiday season.

While the manufacturing sector is small in comparison to the services one, the release is not only the first for the new year but also the initial hint toward Friday's all-important Nonfarm Payrolls. The employment component and also the Prices Paid one – reflecting inflation expectations – are all of high importance. The economic calendar points to drops in all three – and that could be a mistake.

Headline pessimism

The headline ISM Manufacturing PMI is set to retreat from 61.1 to 60.2 points, still well above the 50-point threshold separating expansion from contraction. Nevertheless, America's rapid growth in recent months may have pushed demand higher. Moreover, economists underestimated the headline in the past four months.

Source: FXStreet

Inflation down?

News of the Omicron covid variant dominated the headlines during December and may have pushed consumers toward purchasing goods and shying away from services. That not only pushes the headline higher but also inflation. 

While supply-chain issues have shown some signs of subsiding, strong demand around the holiday season may have caused manufacturers to raise prices. Nevertheless, the calendar is pointing to a decline in the Prices Paid component from 82.4 to 79.5 points in November.

An advance back to the peak of 92.1 points seen in June is unlikely, but an upward move cannot be ruled out. As the Federal Reserve is focused on inflation, an increase cannot be ruled out. 

Source: FXStreet

Employment toward the NFP

The third component to look out for is the Employment one – which serves as a direct hint toward Friday's jobs report. And also here, no surprises – economists expect a drop from 53.3 to 52.7 points. It is essential to note that this component is closer to the 50-point threshold, despite massive hiring.

There is room for an increase also here, and that would add to the trend seen in recent months, as the chart shows:

Source: FXStreet

If two of three components – or all of them – merely meet estimates instead of falling, the dollar would rise. Investors would see the publication as proof of the resiliency of America's economy – and the Fed would also take notice. An economy that is creating jobs and pushing inflation higher is one that warrants raising rates sooner rather than later. The "lift-off" could happen as soon as March when the bank's tapering scheme ends. 

In case the arguments above do not hold, there is room for downside in the greenback, as it would show moderating inflation and slower hiring, allowing the Fed some breathing space. 

Final thoughts

The ISM Manufacturing PMI for December 2021 is set to have more impact than usual as it is the first significant release after the holiday season – and also provides clues about both inflation and employment, the Fed's twin mandates. Economists expect retreats in all critical elements, but that may be wrong due to robust hiring and stronger demand for manufactured goods. The dollar has room to rise in response to marginally better outcomes.