ISM Non-Manufacturing (MAY) (14:00 GMT)
Expected: 55.8
Previous: 56.0

ISM Prices Paid (MAY) (14:00 GMT)
Expected: 61.0
Previous: 63.5

How Will The Markets React?

Conditions have changed drastically between this and last week. Last week, US dollar, equities and treasury traders had a full docket of top-tier economic releases off of which they could trade. In fact, the fundamental scene heated up into the end of the week when event risk peaked on the potentially volatile combination of the ISM Manufacturing and non-farm payrolls indicators – the top two movers for 2006. However, as indicator after indicator crossed the wires with only minor influence on US-based assets, the outlook for sustained bullish momentum quickly faded. Friday’s data offered the last chance for a redeeming burst in fundamental strength; but even the reliable NFP number couldn’t rouse the markets. When the last of the numbers crossed the ticker on last week, many short-term traders squared positions or otherwise prepared for range conditions. For this week, fundamentalists marked only two indicators to keep an eye on: the ISM non-manufacturing indicator and physical trade account. The trade balance is not due until Friday, and it has not been known to move the markets in recent months. Tomorrow’s ISM services survey on the other hand has produced considerable action across the markets in the past. Benchmarking the report to current speculation, economists have forecasted a very small adjustment for the May survey. A step down to a 55.8 read from April’s 56 print would seem logical given the supportive data available. Demand from the consumer has cooled as confidence eases and earnings growth decelerates. What’s more, gasoline prices were commanding a greater portion of discretionary income. The most convincing piece of data for a slightly cooler service activity read though is the modest change in the ISM manufacturing gauge. While all of these issues are valid contributors to the official consensus, they are not perfect. It is when the market is lulled into complacency with modest expectations that a fundamental shock has the greatest influence.

Bonds – US 10-Year Treasury Note Futures

Treasury futures on the ten-year note reported the biggest increase in price in over three weeks Monday. Until this morning, yields have advanced consistently through fundamentally heavy days with little more than a slight pull back. However, once the economic calendar finally lifted the burden for the risk adverse, yields were finally put off of their path. This suggests that yields have rallied on the underlying belief that data is keeping the Fed from cutting interest rates; and the crimp in the flow has left the market high and dry without necessarily insuring a cut is not on the agenda before the year is out. Tomorrow’s calendar threatens to officially change the trend through a soft ISM services report. On the other hand, even a modest surprise could put yields moving higher again.

FX – EUR/USD

Over the past week, EUR/USD has held within a steady range of 1.34 - 1.35 as markets anxiously await the European Central Bank’s next move. However, Tuesday’s release of ISM Non-Manufacturing will first inject a bit of volatility into the US dollar with the services sector gauge anticipated to ease back. The breakdown of the index should prove equally important to EUR/USD price action, and traders will scour the reading for three factors: prices paid, new orders, and employment. The price component may prove to be just as critical as new orders, as the Federal Reserve remains concerned about persistent inflation pressures. Thus, an unexpected jump in prices paid could prove to be quite bullish for the US dollar and may take EUR/USD down towards 1.3400, as the Federal Reserve would be more likely to maintain its hawkish stance. The employment component will also be worth noting as a gauge for broad labor market conditions, but since Non-Farm Payrolls for the month of May have already been released, its importance will be limited. On the other hand, the combination of a soft ISM Non-Manufacturing reading led by weaker orders AND prices would be bearish for the US dollar and has the potential to push EUR/USD higher for a break of 1.3500.

Equities – S&P 500 Index

US equity markets traded cautiously for most of the day on Monday following the 8.3 percent plunge in China’s Shanghai index overnight. However, a last minute rally brought the S&P 500 to close 0.18 percent higher at 1,539.18. Energy stocks, which were buoyed by higher oil prices, led gains among the main industry groups in the S&P 500 index. Shares in Dominion Resources gained 0.3 percent to $87.87 after the company sold much of its gas and oil exploration operations for $6.5 billion, subsequently helping XTO Energy shares to rise 5.6 percent to $61.61 after the natural gas producer said it would pay about $2.5 billion for some of Dominion’s assets. Meanwhile, Loews shares rose 2.6 percent to $52.35 after the conglomerate agreed to pay about $4.03 billion for Dominion’s gas assets.

The S&P 500 could prove lackluster once again on Tuesday, as ISM Non-Manufacturing is anticipated to ease back to a reading of 55.8. The gauge of activity in the services sector will be scoured for three factors: prices paid, new orders, and employment. The price component may prove to be just as critical as new orders, as the Federal Reserve remains concerned about persistent inflation pressures. Thus, an unexpected jump in prices paid could prove to be quite bearish for US equity markets and lead the S&P 500 down towards 1,500, as the Federal Reserve would be more likely to maintain its hawkish stance. The employment component will also be worth noting as a gauge for broad labor market conditions, but since Non-Farm Payrolls for the month of May have already been released, its importance will be limited. On the other hand, a surprise improvement in the headline reading would add to optimism regarding growth prospects for later in the year and could help fuel further US equity market gains.

John Kicklighter is a Currency Strategist at FXCM.