ISM Manufacturing (DEC) (15:00 GMT; 10:00 EST)
Expected: 50.5
Previous: 50.8

What Are The Markets Facing?

On Wednesday, ISM manufacturing is expected to fall to a one year 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, January 4, the ISM employment index will be eyed. Indeed, a sharp drop in this number last month coincided with a drop to 94k from 170k in the highly market-moving non-farm payrolls report. If this particular index holds below the critical 50 level once again, 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 94K. Traders will also be watching the prices paid component, as the index is predicted to ease to 65.0 from 67.5, signaling that inflation pressures are stabilizing and raising speculation that the Federal Reserve will cut rates again in January to calm the instability of the financial markets and to stave off a recession. Indeed, traders will also be scouring the release of the minutes from the FOMC’s December meeting for clues as to their next policy move, as there are concerns the bank will leave rates unchanged in an effort to limit the acceleration of consumer price growth. In fact, Richmond Fed President Jeffrey Lacker, an alternate voting member on the FOMC, said recently: “I have to say that I am uncomfortable with the inflation picture, and disappointed that the improvement we saw earlier this year was not more lasting.” Nevertheless, despite such commentary that suggests the Fed will not reduce the federal funds rate next month, futures markets show a 90 percent chance that the Fed will cut rates by 25bp, and this will continue to be reflected in price action in the FX, bond, and equity markets upon more evidence of deteriorating economic conditions.

Bonds – 10-Year Treasury Note Futures

Treasury note futures have fallen into a descending channel pattern on the daily charts, providing a bearish bias for the contract. However, if equity markets continue to falter, this could play into Treasury gains towards resistance at 113-19 and the closing high of 113-30. Furthermore, if ISM manufacturing proves to be disappointing and the FOMC minutes are dovish, markets may ramp up speculation of a January Fed cut, which would boost Treasuries towards said resistance. Support sits at 112-21 and 112-07.

FX – EUR/USD

The Euro rallied nearly 3 percent last week and has gone to test resistance at 1.4750, as the greenback tumbled amidst heightened risk aversion following the assassination of former Pakistani PM Benazir Bhutto. As we said recently, “data has been broadly mixed as of late, with consumer confidence and spending reports surprisingly proving to be more optimistic, while production and housing figures have been broadly disappointing. Nevertheless, with risks for the US economy vastly to the downside and the Federal Reserve still perceived as being dovish, it is little wonder the greenback is so susceptible to losses, especially at times of geopolitical distress.” Technical Strategist Jamie Saettele has called for EUR/USD to target 1.50 and beyond based on Elliot Wave analysis, and with trading volumes still thin and FX markets prone to sharp moves as we near the New Year, Wednesday’s event risk could trigger some wild price action. First, an ISM report is forecasted to reflect deterioration in the manufacturing sector, while the minutes from the FOMC’s December meeting will provide clues as to the central bank’s next move in January. The fundamentals are likely to be dovish, supporting the case for additional EUR/USD gains, but if the minutes suggest that the Fed will not cut rates again next month, the pair could finally pull back towards 1.4500.

Equities – Dow Jones Industrial Average

Declines in the Dow Jones Industrial Average have paused at 200 SMA support amidst thin trading volumes. Where the Dow goes from here will depend primarily on the status of risk aversion in the markets as well as financial market news, but it is worth noting that resistance looms above near 13,600 while support is below near 13,200. On Wednesday, the release of ISM manufacturing could weigh the Dow lower, as continuously deteriorating conditions in the sector will not bode well for the economy as a whole. However, the minutes of the FOMC’s December meeting will likely play a greater role in equity market price action, as signs that the bank has little confidence on the health of the economy could be the trigger to push the Dow below near-term support.

Terri Belkas is a Currency Strategist at FXCM.