Will ISM Non-Manufacturing Signal A Rebound In Friday's NFP Report?

OCT 3
ISM Non-Manufacturing (SEP) (10:00 EST; 14:00 GMT)

Expected: 54.6

Previous: 55.8


How Will The Markets React?

Conditions in the US non-manufacturing sectors – which account for approximately 70 percent of total economic activity in the country and include retail, services, and finance – are anticipated to have deteriorated during September, as the Institute for Supply Management index is estimated to fall to 54.6 from 55.8. The highest readings we’ve seen in the non-manufacturing report have consistently been in the ‘prices paid’ component, which has only underpinned Federal Reserve Bank inflation hawks’ concerns. However, the price index is expected to ease back for the third consecutive month in September, supporting broad market speculation of additional rate cuts by the central bank throughout the rest of the year. Furthermore, the ‘employment’ component unexpectedly plummeted down through the 50 level in August to 47.9 – marking a contraction – which was followed by a dismal non-farm payrolls report just a few days later. As a result, traders will be watching this component once again, as another reading below 50 would bode very ill for this Friday’s NFP report (October 5th), especially as the US financial and housing sectors are likely to have racked up substantial job losses during the month. As a result, now that the Federal Reserve has finally started to note major downside risks to growth and has stopped focusing on inflation, signs that the labor force is diminishing could lead markets to ramp up speculation of a 25 basis point rate cut in October. Additionally, softer spending in the non-manufacturing sectors could be an early signal of diminishing consumption growth in the US, upping the ante for an all-out economic recession.

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Bonds – 10-Year Treasury Note Futures

Treasury note futures remain contained to an ascending channel, possibly aiming to target the 109-28 level, and the release of ISM non-manufacturing on Wednesday may only boost the contracts as the figure could prove to be even worse than expected. Furthermore, US equity markets could continue to ease back from the recent record highs, bolstering the case for Treasury gains. However, if we see equities rocket higher once again, the contract could start to ease back towards trendline support at 109-04.



FX – EUR/USD

EUR/USD has finally started to ease back from its record highs – though they are still a stone’s throw away – as the pace of the pair’s rally slows. The broad weakness of the US dollar hasn’t received any help from economic data as home sales, labor market, consumer confidence, and inflation reports all proved to be softer-than-expected. The greenback may face another round of disappointing news as the ISM non-manufacturing index is scheduled to be released on Wednesday. The index is expected to ease back, but traders should keep an eye on the employment component, which may be useful in gauging the result of this Friday’s labor market data. However, the actual impact of ISM non-manufacturing on EUR/USD may be limited as traders will be anxiously awaiting the non-farm payrolls report at the end of the week. Nevertheless, if pending home sales are worse than expected, EUR/USD would target the recent record high if 1.4284. However, if the release of the non-manufacturing sector data proves to be surprisingly positive, traders may start to speculate that the retail and services sectors continue to fare well despite the economic slowdown, which could help send EUR/USD down to test 1.4110/20, with sharper declines taking aim on 1.4070.



Equities – Dow Jones Industrial Average

The Dow Jones Industrial Average backed off from Monday’s record high of 14,115.51, though price simply consolidated within a tight 100 point range. With major market-moving data scheduled to be released on Friday (non-farm payrolls report), US equities will likely stick to range trading. There is little consensus on whether the stock market rally will continue to plow on as investors ramp up speculation of another FOMC rate cut in October, or if things will take a grim turn as traders realize that the central bank’s policy actions may not be enough to halt an all-out recession. Nevertheless, if Wednesday’s ISM non-manufacturing figure weakens more than expected, the Dow could return its focus on a break below 14,000. On the other hand, “irrational exuberance” may continue to rule, and if the data is actually somewhat optimistic or simply in line with expectations, the equity index could hold aloft and continue its trek towards 14,200.

US Fed: One and Done?US Fed: One and Done?

Written by Terri Belkas, Currency Analyst
With the FOMC’s next rate decision looming on October 31st, the markets are anxiously wondering if the central bank will cut rates again. Given the Dow’s rapid ascent to fresh record highs, it appears that equity investors are betting the bank that they will indeed cut again. Nevertheless, it’s the US Dollar that stands to benefit the most if the FOMC decides to leave rates unchanged, as the currency recently hit fresh 15-year lows on a trade-weighted basis. While core inflation may have moderated, rising costs for volatile items such as food and energy create the risk of surging price pressures. As a result, the FOMC is in a precarious position: will they ignore inflation risks and move to support the US equity markets with a rate cut?

This Week In Central Bank Speak:
US Fed: One and Done?
ECB: With EUR/USD Above 1.40, Can the ECB Afford to Hike?


Yield Spread Analysis 09/25 – 10/02

Over the course of last week, a spate of dour economic news led government bonds to work their way higher and sending long-term yields plummeting. Meanwhile, short-term yields slowly eased back, as traders bet that they would not encounter policy moves by any of the major central banks. In fact, despite broadly dismal fundamental data out of the US, the nation’s yield curve actually flattened out somewhat as investors started to bet that the FOMC will not be as aggressive in cutting rates during the month of October.

Looking ahead, government bond traders will be watching the ECB and BOE meetings on Thursday. While neither bank is expected to hike, any commentary from ECB President Trichet during his press conference signaling whether or not they will hike before year could send the fixed income, forex, and equity markets reeling. Meanwhile, the BOE does not typically issue policy statements after their meetings, but since they did during their September meeting, markets will be looking for a repeat as well as clues into the bank’s next move.

Australian Dollar Reaches Record High

The Australian Dollar recently touched a 20-year high against the USD, having risen 15% in the last month alone. In fact, the currency has proved to be one of the top performers against the USD in 2007, having benefited from continued weakness in the US economy. It has also been one of the chief beneficiaries of the Yen carry trade, in which investors have sold Yen in favor of higher-yielding currencies, which also include the Swiss Franc and New Zealand Dollar. Meanwhile, Australia's economy is surging, as Chinese demand for raw materials is unabated. Many analysts are asserting that the Australian Dollar can go no higher, citing technical factors. However, there seems to be just as many analysts who expect the AUD to test the outer limits of parity with the USD. The Sydney Morning Herald reports:


The chief equities economist at CommSec, Craig James, said the dollar was now likely to enter the “nervous nineties.”

Global forex volume surges

The Bank of International Settlements just released the results from its first survey of Central Banks in over three years, and the results were startling. Forex volume rose 71% to $3.2 trillion per day, cementing the status of forex as the world's largest market. Trading in forex derivatives also surged, to an average of over $2 trillion per day. While the role of the USD has slipped somewhat, it remains the world's reserve currency as evidenced by the fact that it represents over 40% of all forex volume. FinFacts reports:

"A significant expansion in the activity of investor groups including hedge funds" as well as individual investors also contributed to the increase."

Bank of UK to lower rates

The Central Bank of the UK will likely lower interest rates at its next meeting, following the lead of the Fed. The most recent British economic data indicated that inflation has fallen to its lowest level in over a year. Moreover, UK (and European for that matter) monetary policy prioritizes price stability over employment, by unofficially targeting an inflation benchmark. Thus, without regard to economic growth, the Bank of UK will adjust interest rates accordingly. While the Pound-Dollar exchange rate is less sensitive to relative interest rates, the Pound has already fallen against the Euro, since the two countries compete over foreign capital. Bloomberg News reports:

"The move down is probably going to continue. Sterling will remain under pressure. If any major central bank is going to emulate the Fed and cut rates, it's going to be the BOE.''

Fed Chiefs Act Alike in Crisis

Alan Greenspan, former President of America's Federal Reserve Bank, gained notoriety as well as universal trust based on his perceived ability to conduct monetary policy in exactly the way that the US economy demanded. It was initially thought that his successor, Ben Bernanke, who has been in office for over a year, would have a more difficult time facilitating economic growth and avoiding recession because his primary goal was to control inflation. In practice, however, the two leaders have conducted monetary policy in much the same way, balancing the dual risks of inflation and unemployment. Thus, even though inflation remains above the Fed's comfort zone, Bernanke engineered a 50 basis point rate cut at the last meeting of the Fed in order to avoid economic recession. However, whether the Fed will prioritize unemployment (rate cuts) or inflation (rate hikes) is anyone's guess. Dollar bulls will no doubt be watching with bated breath, praying that he prioritizes inflation. The New York Times reports:

“Where Greenspan had to hold off raising rates when the economy was strong. Bernanke's challenge will be to hold off cutting rates when the economy slows down.”

FXCM offers Fractional Pip Pricing

Forex Capital Markets LLC, the largest Forex Dealer Member, recently announced that it would begin offering so-called “Fractional Pip Pricing” in an effort to reduce the bid-ask spreads it offers customers. Previously, most, if not all forex brokers that cater to retail forex investors, quoted forex rates out to four decimal places (i.e. 1.4101 USD/Euro). However, due to its strong liquidity relationships with banks that facilitate forex trading, FXCM has negotiated tighter bid-ask spreads for its customers, which will enable it to quote exchange rates to five decimal places (i.e. 1.41007 USD/Euro. While FXCM expects to narrow spreads further in the future, it remains to be seen whether the competition will follow suit.

Adjusting to Life at Parity

Over the last five years, the Canadian Dollar has slowly climbed to parity against the USD, finally reaching the mythical 1:1 exchange rate last week. Canadian shoppers and American tourists have taken notice, gradually adjusting their behavior in accordance wit their changing purchasing power. For many Canadians, this has translated into more frequent shopping trips across the border, whether for gasoline or for clothing. For Americans, this has resulted in a decline in the number of tourists visiting Canada. It is also slowly redefining the US-Canada trade dynamic. However, as Canada has become the United States’ largest supplier of oil, it is likely Canada that will benefit most in this relationship. The New York Times reports:

The weakness of the American dollar worries some Canadian investors as well as businesses that rely on American customers.

The Yen Also Rises

The Japanese Yen is finally appreciating, though how long the upward streak will last is anyone’s guess. These days, the Yen rises and falls on the whims of carry traders. However, the enemy of the carry trade is volatility and the Fed’s lowering of US interest rates injected enough uncertainty into the markets to send carry traders slowly towards the exit. As a result, currencies such as the Australian Dollar and New Zealand Kiwi, long popular with in carry trading circles, were quickly dumped as traders bought Yen to cover their positions. Whether the Yen can sustain its momentum depends primarily on the Central Bank of Japan. Bloomberg News reports:

Carry trades utilizing the New Zealand dollar lost 1.9 percent today, according to data compiled by Bloomberg, after gaining 2.3 percent so far this week as the Federal Reserve reduced the U.S. rate a half percentage point to 4.75 percent.