US ISM Services PMI Preview: Healthy expansion to continue in February

The United States (US) will publish the Institute for Supply Management (ISM) Services Purchasing Managers Index (PMI) on Tuesday. The February index is foreseen at 53.0, easing slightly from the previous 53.4.

Back in January, the report highlighted a continued economic expansion as the services sector grew for the thirteenth consecutive month and underscored the resilience of the service sector. The modest down-tick expected in February should not affect the market optimism regarding the US economic health.

Furthermore, the Business Activity Index remained stable at 55.8, suggesting steady business operations, while the New Orders Index expanded by 2.2 percentage points from December, reflecting increased demand for services. On a down note, the Prices Index sub-component surged to 64, posting quite a significant increase of 7.3 points from the previous month.

Inflation and the Federal Reserve

Inflation had been a significant concern in the US, but the release of the January Personal Consumption Expenditures (PCE) Price Index last week poured cold water on such concerns. The Core PCE index rose 0.4% for the month and 2.8% from a year ago, meeting the market expectations and posting the slowest annual increase since March 2021.

The figures are relevant as they are the Federal Reserve’s (Fed) most watched inflation gauge. And while other macroeconomic indicators may suggest increased price pressures over a certain period, the fact is that the central bank makes its decision based on this one. As long as PCE inflation remains subdued, policymakers will set aside their concerns and any additional monetary tightening.

However, the situation is a bit more complex. Financial markets hoped the US central bank would quickly revert its monetary policy and loosen it, given receding inflation. Nevertheless, the Fed seems comfortable with its wait-and-see stance, and a rate cut is not expected until June.  The Price Index sub-component needs to be extremely high to trigger an alarm, which anyway would need additional confirmation from other macroeconomic indicators through the next couple of months.

Meanwhile, a Services PMI reading in line with the market expectations should have a limited impact on the US Dollar, as it would confirm what the market already knows: that the economy keeps expanding while price pressures are still above the Fed’s 2% goal but moving in the right direction.

An unexpectedly sharp decline would have a higher impact than a contrarian result. The services sector has remained the strongest throughout the last couple of years, and an improvement there should not be as big of a surprise as a sudden contraction. The latter should trigger risk aversion, and weigh on high-yielding assets, ending up backing modest USD demand.

Dollar Index technical outlook

Ahead of the announcement, the Dollar Index (DXY) is range bound. The DXY stands below the 104.00 mark, having traded as low as 103.43 and as high as 104.29 for over a week now. The modest intraday uptick falls short of suggesting a bullish extension. Beyond the aforementioned 104.29 level, the index posted a multi-week high at 104.97, the level that it needs to surpass to actually gain upward momentum.

From a technical perspective, the daily chart shows technical indicators pulling down within neutral levels, suggesting scarce demand. At the same time, the DXY is confined between directionless moving averages, reinforcing the idea of absent interest. The risk of a bearish extension should increase on a break below the 103.40 region, with scope then for a test of the 102.90 area. Once below the latter, the US Dollar would be in trouble, and an approach to 102.00 would be on the cards.