US dollar drops to three-week low after soft manufacturing data

The dollar fell to a three-week low on Monday after data showed the U.S. economy is slowing down with weaker-than-expected readings on manufacturing and construction spending, suggesting that the Federal Reserve is on track to start cutting interest rates this year.

The greenback fell to a two-week low against the yen following the data and was last down 0.6% at 156.245 USDJPY.

The euro gained 0.3% to $1.0879 EURUSD, pushing the dollar index, a measure of the U.S. currency's value versus six major currencies, down 0.3% as well to 104.24 DXY. The index earlier dropped to a three-week low of 104.22.

The U.S. Institute for Supply Management (ISM) said its purchasing managers index (PMI) for manufacturing fell to 48.7 in May , from 49.2 in April, sliding as well from an 18-month high of 50.3 seen in March.

In a research note, BMO pointed out that the U.S. manufacturing sector in May shrank for the eighteenth time in the past nineteen months.

Monday's ISM decline followed weakness in the Chicago PMI, Dallas Fed, Philadelphia Fed indexes, and the Empire State manufacturing indexes.

U.S. construction spending also slid unexpectedly for a second consecutive month in April, decreasing by 0.1% after a 0.2% decline in March, amid falls in non-residential activity.

"The U.S. manufacturing sector is expected to remain under pressure until the Fed starts to loosen monetary policy in the fall," wrote Jay Hawkins, senior economist at BMO Capital Markets in a research note.

After the ISM and construction spending data, fed funds futures increased the chances of a rate cut in September to around 59.1%, according to LSEG's rate probability app, compared with around 55% late Friday. It was slightly below 50% earlier last week.

The U.S. dollar posted its first monthly decline of the year in May, weighed down by shifting expectations on when the U.S. central bank will cut rates and by how much. The futures market is fully pricing in one rate cut of 25 bps this year.

"It's pretty clear that the Fed is going to be on hold for a while," said Brad Bechtel, global head of FX, at Jefferies in New York. "The U.S. data matters but they're probably not going to move the needle."

"The dollar (index) is going to be trading in a range, at least for the remainder of the year, which is going to be in the 103-107 area. For the next couple of weeks, we might just hold in the 104-105 range."

In other currencies, the Mexican peso weakened on Monday after the ruling party declared Claudia Sheinbaum the winner of the presidential election by a "large margin" after polls closed on Sunday.

"The peso is underperforming amid seemingly growing concerns amongst investors that by securing supermajority in the lower house the governing coalition could be tempted to implement non-market-friendly policies," said Piotr Matys, senior FX analyst, at In Touch Capital Markets.

The U.S. dollar was last up 3.1% at 17.52 pesos USDMXN.