ISM Manufacturing (AUG) (10:00 ET; 14:00 GMT)
Expected: 53.0
Previous: 53.8

ISM Prices Paid (AUG) (10:00 ET; 14:00 GMT)
Expected: 63.0
Previous: 65.0

How Will The Markets React?

Conditions in the US manufacturing sector are anticipated to deteriorate for the second month in a row during August, as the Institute for Supply Management index is estimated to fall to 53.0 from 53.8. Over the past few periods, we’ve seen that the weaker US dollar has helped contribute to the ‘new export orders’ component, as American products prove to be cheaper and more attractive, while the broader ‘new orders’ index has staged a strong recovery after falling below the 50 boom/bust level last November. Meanwhile, the highest readings we’ve seen in the ISM manufacturing report have consistently been in the ‘prices paid’ component, which has only underpinned Federal Reserve Bank inflation hawks’ concerns. However, the price index is expected to ease back further in August, supporting broad market speculation of a rate cut by the central bank in September. Furthermore, the ‘employment’ component has struggled to hold above 50 throughout the year, and an index reading below that figure in August (marking a contraction) would bode very ill for this Friday’s NFP report, especially as the US financial sector is likely to have racked up substantial job losses during the month. As a result, now that the Federal Reserve has finally started to note major downside risks to growth and has stopped focusing on inflation, signs that the labor force is starting to suffer could lead markets to ramp up speculation of a 25 basis point rate cut in September.

Bonds – 10-Year Treasury Note Futures

The back and forth price action of the past several sessions in 10-year Treasury note futures appears to be developing into another bullish continuation pattern, especially since price was able to hold above the prior range highs on a closing basis at 108-29. That leaves the pattern of higher highs and higher lows intact on the daily chart with the contract likely to target 110-00. The release of ISM manufacturing on Tuesday may only help the case for further Treasury gains, as the index is anticipated to fall back, supporting the case for a rate cut by the Federal Reserve in September.

FX – EUR/USD

Despite volatile price action on Friday, the EUR/USD pair remains range bound, as mixed risk averse sentiment keeps US dollar traders on edge. Outside of the 1.3565 – 1.3685 range, the next level of resistance sits at the 78.6% fib at 1.3750, which could be the pair’s next bullish target. However, EUR/USD faces massive event risk on Tuesday and the pair’s reaction may sound counterintuitive, as signs that the Federal Reserve will cut rates in September could send EUR/USD higher as the US dollar has traded more as a safe-haven asset over the past few weeks and the data would help to assuage credit crunch concerns. Furthermore, the prospect of lower interest rates would limit the dollar’s attractiveness in terms of carry trade differentials. On the other hand, if the ISM manufacturing report remains strong and signals resilient price growth and resilient employment conditions, equity markets could unravel as risk averse sentiment returns and pushes EUR/USD down towards support at 1.3565, with sharp declines taking on 1.3485.

Equities – Dow Jones Industrial Average

The Dow Jones Industrial Average broke above a descending trendline on Friday, ending the day up 0.9 percent at 13,357.74. This trendline had blocked gains for the equity index since late July, and the Dow’s move above this level signals that price could be moving higher to complete a 78.6 percent retracement of the decline from the August 17th high at 13,700, but this will only be possible if credit jitters subside. On the other hand, if Friday’s jump proves to be a false break, the Dow could ease back to target the 200 SMA at 12,898 once again. Furthermore, resistance at the 61.8 percent retracement level of the previously noted decline at 13,447 could limit gains. US equities face event risk from Tuesday’s ISM manufacturing report, and signs that conditions in the sector are deteriorating that may force the Fed to cut rates on September 18th could send the Dow skyrocketing.

Terri Belkas is a Currency Strategist at FXCM.