ISM Manufacturing (Feb) (15:00 GMT; 10:00 EST)
Expected: 49.0
Previous: 50.7

What Are The Markets Facing?

After sparking fears of a recession, Chairman Bernanke followed that up with evoking memories of the Savings and Loans Crisis, when he warned of possible bank failures. He followed that up by saying that he didn’t feel that we were heading into a recession and that inflation wouldn’t be a factor in the future. So how bad is the economy? Upcoming, ISM Manufacturing may give us an insight into the direction of the economy as its prices paid and employment components are leading indicators for future CPI data and Nonfarm payrolls. The gauge is expected to decline below the 50 boom/bust level signaling contraction, but it may surprise as it did the prior month, as the sector is expected to reap benefits from the declining dollar. Many are hoping that international demand for U.S. goods can keep the economy afloat until recent Fed rate cuts have their intended affect. The reading may also benefit from a resilient U.S. consumer as personal spending and income grew more than expected in January. However, with the Philadelphia, New York and Chicago manufacturing indicators all coming in lower than expected, there isn’t much hope for a surprise here.

Bonds – 10-Year Treasury Note Futures

After breaking out from its falling wedge, treasuries are expected to run into resistance at 118.03, the January high. Fed Chairman Bernanke’s recent testimony has reignited recession fear and a flight to safety driving up bond prices. A weaker than expected ISM Manufacturing, which is expected to decline, should push treasuries through resistance and test the yearly high of 119.05. While a stronger number, especially the employment component may calm recession fears and lead to money flowing out of treasuries, and the price retracing.

FX – EUR/USD

Bernanke’s testimony and stronger than expected European economic data pushed the Euro to a new all time high of 1.5238. After successive days of setting fresh all time highs and breaking new barriers, traders may look to take a breather and lock it some of their recent gains. The pair may retrace to the once unattainable 1.50, which may serve as the new support level. As recession fears grow in the U.S. and the European economy continues to show signs of decoupling, the interest rate differential is expected to grow. The ECB isn’t expected to cut rates at their March 6 meeting and traders are pricing in an 86% chance the Fed will cut rates by 1% over their next two meetings, this will only strengthen the case for Euro bulls. Upcoming ISM manufacturing is expected to throw more dirt on the dollar, as it is expected to decline, a lower than expected number will reignite recession fears and may push the Euro to as high as 1.54. Especially, considering that expectations are that U.S. manufacturers will benefit from the weak dollar. If the indicator exceeds expectations and shows that benefits are being attained, it may reduce recession fears and spark a dollar rally.

Equities – Dow Jones Industrial Average

After three days of gains on expectations that the Fed will continue to cut rates, the market had a triple digit loss as recession fears were increased by Fed Chairman Bernanke’s testimony. The Dow, which was already suffering losses, dropped when he warned of possible bank failures and evoked memories of the S&L crisis. The economy is continuing to show signs of slowing as GDP fourth quarter estimates, which has traders moving their money into safer vehicles like treasuries and commodities. If the manufacturing sector shows signs of weakening, as the ISM indicator is expected to print lower, it will force traders to turn away from one of the few sectors that they expected growth and send the Dow lower to test support at 12,150. However, if U.S. manufacturing shows that it is reaping benefits from a weak dollar; traders will look to play the sector and may rally the index.

Terri Belkas is a Currency Strategist at FXCM.