EUR/USD: Trading the U.S. ISM Manufacturing Report

Trading the News: U.S. ISM Manufacturing

Why Is This Event Important:

The FOMC maintained a cautious tone in its August monetary policy meeting minutes and said economic activity in the second half could be more modest than initially expected, and warned that the recovery may weaken further as the effects of the fiscal stimulus tapers off.

What’s Expected:

Time of release:09/01/2010 14:00 GMT, 10:00 EST

Primary Pair Impact :EURUSD

Expected: 52.8

Previous: 55.5

Will This Be Market Moving (Scenarios):

The ISM Manufacturing index is forecasted to fall back to 52.8 in August from 55.5 in the previous month, which would be the slowest pace of expansion since last September, while the gauge for prices paid is projected to weaken to 55.3 from 57.5 in the previous month, and the data could stoke selling pressures for the greenback as investors weigh the prospects for future growth. However, as risk trends continue to dictate price action in the currency market, the U.S. dollar could move inversely to the fundamental development and push higher against its major counterparts as it benefits from safe-haven flows.

The Upside

Given the rebound in global trade paired with the rise in private consumption, businesses may increase manufacturing at a faster pace in August as they build up their stockpiles of unsold goods. As a result, an enhanced ISM report could spur a bullish reaction in the greenback and push the EUR/USD out of its narrow range as the growth prospects for the world’s largest economy improves.

The Downside

However, the downward revision in the 2Q growth rate paired with the slower pace of business investments suggests firms are keeping a lid on production as policy makers maintain a cautious outlook for the economy, and companies may scale back on production further over the coming months as they continue to tightening credit conditions paired with limited demands. Accordingly, investors may raise bets for the Fed to maintain a loose policy stance going into 2011 as the central bank aims to mitigate the downside risks for growth and inflation, and the MPC may see scope to take additional steps to support the economy over the coming months in an effort to foster a sustainable recovery.

How To Trade This Event Risk

Trading the given event risk clearly favors a bearish outlook for the greenback but nevertheless, an enhanced manufacturing report could set the stage for a long dollar trade as the economic outlook improves. Therefore, if the ISM index unexpectedly bounds back to 57.0 or higher in August, we will need to see a red, five-minute candle following the release to establish a sell entry on two-lots of EUR/USD. Once these conditions are fulfilled, we will set the initial stop at the nearby swing low or a reasonable distance, and this risk will generate our first target. The second objective will be based on discretion, and we will move the stop on the second lot to breakeven once the first trade reaches its mark in an effort to lock-in our profits.

In contrast, the ongoing weakness in the real economy paired with the cautious tone held by the central bank could lead businesses to scale back on production, and a dismal ISM report could spark a bearish reaction in the greenback as the prospects for a sustainable recovery deteriorate. As a result, if the index slips to 52.8 or lower, we could see some weakness in the reserve currency, and we will implement the same strategy for a long euro-dollar trade as the short position laid out above, just in reverse.

Potential Price Targets For The Release

Impact that U.S. ISM Manufacturing has had on USD during the last month

July 2010 U.S. ISM Manufacturing

Manufacturing activity in the world’s largest economy expanded at a slower pace in July, with the ISM index falling back to 55.5 from 56.2 in the previous month, which topped expectations for a 54.5 print, and businesses may continue to scale back on production over the coming months as policy makers expect to see a moderate recovery going forward. A deeper look at the report showed the gauge for new orders slipped to 53.5 from 58.5 in June, with the production index falling to 57.0 from 61.4, while the employment component advanced to 58.6 from 57.8 in the previous month. As the rebound in economic activity cools, the Fed is likely to maintain the expansion in monetary policy in the second-half of the year as Chairman Ben Bernanke pledges to hold borrowing costs close to zero for an “extended” period of time, and the central bank may see scope to provide further support to the economy as the private sector remains weak.

What To Look For Before The Release

Traders with access to market depth information via the FXCM Active Trader Platform may use it to gauge the potency of the economic data release as well as to shed some light on the market’s directional bias. Increasing volume ahead of the announcement will telegraph likely follow-through behind whatever move is to materialize, while an imbalance in available liquidity on the Bid versus the Offer side of the market will tell us the direction major institutions are likely favoring ahead of the announcement:

Bullish Scenario: If we see substantially deeper available liquidity on the Bid side of the market, this tells us that major price providers in the market are looking to buy the EUR against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bullish bias on EURUSD ahead of the data release.

Bearish Scenario: If we see substantially deeper available liquidity on the Offer side of the market, this tells us that major price providers in the market are looking to sell the EUR against the US Dollar. Considering that close to 60% of all FX market volume is cleared through just six top banks, we see it prudent to be on the same side of the trade as major institutions and will favor a bearish bias on EURUSD ahead of the data release.

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To discuss this report contact David Song, Currency Analyst: dsong@fxcm.com