How Will The Markets React?

Conditions in US non-manufacturing sector – which accounts for approximately 70 percent of total economic activity in the country and includes retail, services, and finance – are anticipated to have deteriorated during November, as the Institute for Supply Management index is estimated to fall to 55.0 from 55.8. Indeed, the Federal Reserve’s Beige Book report for November indicated that shipping activity “declined somewhat,” indicating that the orders component will likely lead declines in the ISM index. The highest readings we’ve seen in the non-manufacturing report have consistently been in the ‘prices paid’ component, which has only underpinned the inflation concerns of the Federal Reserve, and the November reading should not be any different. Meanwhile, the ‘employment’ component will be watched carefully ahead of Friday’s non-farm payrolls report, which is expected to only show a gain of 70,000 jobs after they rose 166,000 during the month prior. Overall, the ISM non-manufacturing report is likely to be in line with the FOMC’s policy statement that cited major downside risks to growth that were counterbalanced by upside inflation risks. While these comments suggest that the central bank will not move to cut rates again in December, recent commentary from multiple FOMC members suggests otherwise, leading the markets to aggressively price in a at least a 25bp rate cut, if not a 50bp cut. If this week’s non-manufacturing sector data signals that the services sector may be faltering, fixed income, forex, and equity markets may only continue to price in a reduction in interest rates on December 11.

Bonds – 10-Year Treasury Note Futures

Treasuries have run straight into resistance at 114-10, which has managed to hold the contract back for now, though the rejection of the level is not as severe as last week. With softer US economic data expected throughout the rest of the week, his level may not hold up for long. On Wednesday, ISM non-manufacturing is expected to fall slightly lower, which may only ramp up already lofty expectations of a Fed rate cut next week. However, if the news proves to be surprising, Treasuries could drop towards trendline support at 113-13.

FX – EUR/USD

The EUR/USD remains firmly within its ascending channel, as the pair bounced from trendline support recently to aggressively test 1.4750. Expectations of a rate cut by the Fed next week have certainly helped keep the greenback subdued, and economic data out of the US this week may not help to give the currency a boost. The November ISM non-manufacturing reading is expected to ease back slightly, but the EUR/USD may be especially susceptible to choppy price action if the figure proves to be surprising (to either the upside or downside). Furthermore, traders will be looking at a breakdown of the index to gauge the employment component, as signs of weakness in the labor market may push expectations for this Friday’s non-farm payrolls report lower. As a result, if ISM proves to be softer-than-expected, EUR/USD could push higher for a test if 1.4852 (that is, of course, if the pair can break resistance at 1.4789). On the other hand, a surprisingly strong reading could reignite a bid tone for the greenback, and press EUR/USD back towards trendline support near 1.4600.

Equities – Dow Jones Industrial Average

The rebound in the Dow appears to have been stopped short at the 50 percent retracement level of the decline from 14,198.10 – 12,724.09 at 13,461, as the index has slowly pulled back. Dovish rhetoric from various FOMC members and ramped up expectations of a rate cut next week sparked the gains, but with little in the way of Fed speeches this week, there hasn’t been much to support the Dow. ISM non-manufacturing may not help either, as the figure is expected to show deterioration in the services sector. While this would boost the case for more accommodative monetary policy by the Fed, the news would not bode well for the economy as a whole, especially as the risks of a recession are now being discussed regularly. Declines in the index may target support near 13,071/88. On the other hand, a better than expected figure could spark some mild gains, though the 13,461 level is likely to continue to hold up as solid resistance.

Terri Belkas is a Currency Strategist at FXCM.