US Dollar: ISM Services May Confirm Fed Chairman Bernanke's Recession Fears

Conditions in US non-manufacturing sector – which accounts for approximately 70 percent of total economic activity in the country and includes retail, services, and finance – are anticipated to have deteriorated in March, as the Institute for Supply Management index is estimated to fall to 48.5 from 49.3.

What Are The Markets Facing?

Conditions in US non-manufacturing sector – which accounts for approximately 70 percent of total economic activity in the country and includes retail, services, and finance – are anticipated to have deteriorated in March, as the Institute for Supply Management index is estimated to fall to 48.5 from 49.3. If the index holds below the 50 level as expected, the news will be a very bearish sign for the US economy as the data would only add to the mountain of evidence pointing towards a recession in Q1 2008. Indeed, the index has already held below this critical point over the past two months, as orders and overall business activity have proven lackluster. Like the ISM Manufacturing report, the employment component of ISM Non-Manufacturing will be watched carefully as a gauge for Friday’s Non-farm Payroll report. Thus far, most indicators – including ISM Manufacturing and the ADP employment report – both suggest that labor market conditions improved slightly in March, but still remain in a dismal state. This is unlikely to come as a major surprise to the markets, as even Federal Reserve Chairman Ben Bernanke said on Wednesday, “...in light of the sluggishness of economic activity and other indicators of a softer labor market, I expect it (the unemployment rate) to move somewhat higher in coming months.” Nevertheless, if ISM Non-Manufacturing proves to be very disappointing, the news could lead fed fund futures to quickly price in more aggressive rate cuts – such as a 50bp reduction – in the near term. On the other hand, a reading in line with or better than expectations will leave fed fund futures to continue pricing in a more moderate 25bp cut to 2.00 percent.

 
Bonds – 10-Year Treasury Note Futures

Treasuries remain heavy since backing off from resistance at the 119-12 level, and the contract may ultimately test trendline support at 115-28/30. Upcoming event risk for Treasuries includes ISM Non-Manufacturing, and if the data is surprisingly strong, price is likely to plummet. On the other hand, a disappointing release could lead Treasuries to rebound toward 119-12, as futures will quickly shift to price in a 50bp cut on April 30.

 FX – EUR/USD

The EUR/USD has found support at the 20 SMA after a brief dollar rally, inspired by a rebound in the ISM manufacturing index. The pair has breached the technical support level four of the past eight days, but the lack of significant follow through has prevented a clean break. Chairman Ben Bernanke’s testimony before the joint economic committee failed to provide any clear direction for the pair, despite the affirmation that the economy will experience a contraction in the first half of the year and his lack of concern regarding inflation. Traders have continued to price in a 50 point rate cut at the next Fed meeting, with many speculating that the benchmark rate may ultimately reach a low of 1.00 percent. However, the financial system has started to regain its footing on the back of the recent Bear Stearns bailout and cash infusion by the central bank. The markets have seen confidence and risk appetite start to return, evidenced by reductions in swap spreads and volatility indexes. The upcoming ISM Non-Manufacturing will provide significant evidence as to the extent of the forthcoming economic contraction, and may influence longer term trading trends. A rebound is services may signal a bottom in the economy and will increase speculation that the Fed’s next rate cut will be shallower than expected, which may have dollar bulls looking to retest the 1.54 support level. Conversely, if the industry resumes its downward trend, it will increase recession fears and may push the Euro towards testing 1.600.

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Equities – Dow Jones Industrial Average

The Dow Jones Industrial Average’s bounce from support at the 50% fib of the rally from 11,731 – 12,622 at 12,177 managed to break through the 50 SMA as well. Typically, when we see large gains (such as on Tuesday), the next trading session is relatively subdued (as we’ve seen on Wednesday). Nevertheless, the long-term trend remains to the downside, and in the near-term, substantial resistance looms above at the 12,718/25 level where we have the February highs and the 100 SMA. Risk trends will remain the biggest driver of day-to-day price action, but upcoming ISM Non-Manufacturing data could weigh the DJIA toward trendline support near 12,250, as the index is expected to hold below the 50 boom/bust level for the third consecutive month.

 

 

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