US ISM Manufacturing (JUL) (08:30 ET; 12:30 GMT)
Expected: 55.5
Previous: 56.0

Prices Paid (JUL)
Expected: 65.5
Previous: 68.0

How Will The Markets React?

US financial markets have seen extraordinary volatility through the past week of trade, with domestic equities falling considerably in a matter of days. This has coincided with a likewise violent rally in bond markets, which has left yields substantively below recent heights. Yet the US dollar remains higher through the same period on a flight to safety across all asset classes. The greenback has become the recipient of funds from previously over-leveraged bets on the high-flying carry trade currencies. This status as a safe haven leaves the dollar especially vulnerable to sharp fluctuation in fixed income and equity markets, which makes upcoming economic data important to gauge the direction USD pairs. Wednesday morning’s ISM Manufacturing report is typically a large market mover in forex markets and stocks alike. Given both bonds and equities near critical technical levels, it will be very important to watch how traders react to the US economic release.

Bonds – US 10-Year Treasury Note Futures

Bond futures have shown significant strength through the past two months, with the recent anti-carry shakeout leading the 10-year future to its highest since early May. This has of course led US yields significantly lower through the same period, but such unrelenting declines have recently slowed on technical levels in the underlying asset. Whether or not this stabilization will continue largely depends on upcoming economic data. If bond futures break above key resistance at the 107 and 5/8’s mark, we could easily see US yields fall further off of recent highs. All else remaining equal, such an occurrence would add clear selling pressure to the US dollar across major currency pairs. Of course, a hold below the level could just as easily provide a soft greenback bid. It will be important to gauge sentiment on speculative fixed income issues in forecasting the future of dollar performance.

FX – EUR/USD

Indecisive EUR/USD price action leaves ample room for a US dollar move in either direction on tomorrow’s report, with recent declines leaving a dollar-bullish bias through the near term. Much of the greenback’s performance will largely depend on reactions in other asset classes, but it remains clear that the dollar itself tends to post strong reactions on the closely-followed manufacturing data. Traders will be especially wary of surprises in the ISM Manufacturing Prices Paid index, which typically garners attention as a leading indicator to official inflation figures. The most dollar bullish reaction would undoubtedly be a positive surprise in the headline ISM Manufacturing print and a similarly strong Prices Paid index, with a dollar rally eyeing extension towards the psychologically significant $1.3600 mark. A strongly negative surprise in both indices would spark the opposite move, with the EURUSD to continue its overall uptrend ahead of later-week economic data.

Equities – S&P 500 Index

The S&P 500 may prove especially important to the US dollar, with recent equity market volatility actually serving to boost the downtrodden US currency. Perhaps counterintuitive at first glance, the stock market tumbles have shaken confidence in high-flying Euro and British pound—leaving traders to pull back US dollar short positions. This has of course left the greenback higher in past days of trade, and continued carry trade shakeouts can only continue to boost the currency. As such, it will be important to watch whether domestic equity markets—an appropriate barometer for global risk appetite—can resume their overall uptrend. If the S&P 500 breaks below a year-long trendline and a 200-day moving average at 1450, we could see the US dollar continue its recent advance against high-flying counterparts.

Terri Belkas is a Currency Strategist at FXCM.