US ISM Manufacturing (NOV) (15:00 GMT; 10:00 EST)
Expected: 50.5
Previous: 50.9

US ISM Prices Paid (NOV) (15:00 GMT; 10:00 EST)
Expected: 66.0
Previous: 63.0

How Will The Markets React?

On Monday, ISM manufacturing is expected to fall to a ten-month low of 50.5, just barely above the 50 boom/bust level, suggesting that conditions in the sector remain positive. However, traders will be watching the subcomponents carefully as well. With key US labor market figures scheduled to be released on Friday, December 7, the ISM employment index will be eyed. Indeed, an improvement in this number during the last two months has coincided with gains in the highly market-moving non-farm payrolls report. If this particular index falls below the critical 50 level like it did in March, estimates for the labor market report at the end of the week will be cut back from current expectations of a drop to 70K from 166K. Traders will also be watching the prices paid component, as the index is predicted to jump to 66 from 63 on the back of surging commodity prices, signaling that inflation pressures are mounting. Overall, the ISM manufacturing report is likely to highlight a key issue for the US economy: will the Federal Reserve cut rates in December to calm the instability of the financial markets and to stave off a recession, or leave rates unchanged in an effort to limit the acceleration of consumer price growth? Futures markets show a 66 percent chance that the Fed will cut rates by 25bp, and a 34 percent chance of a sharp 50bp cut. Meanwhile, multiple FOMC voting members, including Fed Chairman Ben Bernanke have issued commentary suggesting that they are more concerned about the health of the financial markets and growth than inflation. Indeed, it appears that evidence is pointing in favor of a reduction in the federal funds rate, and the FX, bond, and equity markets will likely continue to reflect that if ISM manufacturing is released in line with or worse than expectations.

Bonds – 10-Year Treasury Note Futures

Treasuries have been consolidating gains near the 114-00 level, leaving the contract’s uptrend intact but suggesting some hesitance to push beyond the 114-31 high. Nevertheless, a break above short-term trendline resistance at 114-02 may see Treasuries test the highs once again. Coming on the tails of dovish commentary by Fed Chairman Ben Bernanke, US economic data may support the case for Treasury gains as Monday’s ISM manufacturing report is expected to reflect a slowdown in the sector.

FX – EUR/USD

The Euro continues to consolidate near 1.4750, hugging trendline support and keeping the EUR/USD uptrend intact. Hot Euro-zone CPI, dismal US data, and dovish rhetoric from various FOMC voting members have helped keep the pair afloat. However, EUR/USD looks prone to breaking out, with a push above 1.48 targeting 1.4860/70 while a drop below the recent lows of 1.4712 leaves the pair likely to fall to support at 1.4600. Monday’s US event risk could propel EUR/USD higher, as ISM manufacturing is expected to drop, signaling that weakness is spreading throughout the economy and supporting the case for a December rate cut by the Fed. However, if a jump in the price paid component resonates more with the markets, EUR/USD could drop as traders ease back speculation that the central bank will implement more accommodative monetary policy.

Equities – Dow Jones Industrial Average

The recent correction higher of the Dow Jones Industrial Average may have little upside potential left, as the index has run into resistance at the 50 percent retracement level of the decline from 14,198 – 12,724 at 13,461. Thus far, equity traders have been buying up shares as futures aggressively price in a December rate cut by the Federal Reserve. If this sentiment prevails, additional resistance looms at the 61.8 percent retracement level at 13,640, though a turn lower in the Dow seems likely in the near-term. US event risk on Monday may play a small role in price action, with ISM manufacturing expected to show deteriorating conditions in the sector and rising costs. The data could be perceived in two ways: a drop in the headline reading would underpin the case for a Fed cut, and thus, support gains in the Dow. On the other hand, a sharp rise in the prices paid component would remind the markets that inflation pressures may be too great for the central bank to make monetary policy accommodative, which could weigh on the Dow and send the index towards 13,090.

Terri Belkas is a Currency Strategist at FXCM.