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

Trading the News: U.S. ISM Manufacturing

What's Expected:

Time of release: 07/01/2011 14:00 GMT, 10:00 EST

Primary Pair Impact:EURUSD

Expected: 52.0

Previous: 53.5

DailyFX Forecast: 51.0 to 54.0

Why Is This Event Important:

The U.S. ISM Manufacturing index is expected to fall back to 52.0 in June from 53.5 in the previous month, which would be the lowest reading since August 2009, and the slower pace of production could spark a bearish reaction in the U.S. dollar as it dampens the outlook for future growth. As the world's largest economy faces a protracted recovery, the Fed is widely expected to preserve its zero interest rate policy even as it withdraws the additional $600B in quantitative easing, and the central bank may look to maintain the expansion in monetary policy beyond 2011 in an effort to stem the downside risks for the nation. However, the down tick in the ISM could weigh on trader sentiment, and a shift away from risk-taking behavior could lead to U.S. dollar strength as the reserve currency benefits from safe-haven flows.

Recent Economic Developments

The Upside

The Downside

The rise in private sector spending paired with the ongoing expansion in consumer credit may encourage businesses to ramp up their rate of production, and the Fed may adopt an improved outlook for the region as economic activity gather pace. However, as production slumps across most districts, a sharp downturn in the ISM index is likely to instill a weakened outlook for the economy, and the Fed may continue to curb its growth forecast as private sector activity falters. In turn, the FOMC may retain a dovish tone throughout the second-half of the year, and the central bank may see scope to expand monetary policy further as it aims to encourage a sustainable recovery.

Potential Price Targets For The Release

How To Trade This Event Risk

Trading the given event risk certainly reinforces a bearish outlook for the greenback as market participants expect manufacturing to expand at a slower pace in May, but an enhanced ISM report could pave the way for a long U.S. dollar trade as growth prospects improve. Therefore, if the index advances to 54.0 or higher from the previous month, 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 preconditions are fulfilled, we will set the initial stop at the nearby swing high or a reasonable distance from the entry, and this risk will generate our first objective. The second target 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 order to preserve our profits.

On the other hand, the slowdown in global trade paired with the ongoing weakness within the private sector may lead businesses to scale back on production, and a dismal manufacturing report could encourage the Fed to carry the expansion in monetary policy beyond 2011 as it aims to fosters a sustainable recovery. As a result, if the index falls back to 52.0 or lower in June, we will implement the same strategy for a long euro-dollar trade as the short position laid out above, just in reverse.

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

May 2011 U.S. ISM Manufacturing

The ISM manufacturing index fell back to 53.5 in May from 60.4 in the previous month to mark the lowest reading since September 2009, and businesses may continue to scale back on production as demands taper off. A deeper look at the report showed the gauge for new orders fell to 51.0 from 61.7 in April, with new export orders slipping to 55.0 from 62.0, while the employment component weakened for the third consecutive month in May. As the world's largest economy faces a slowing recovery, the Federal Reserve may continue to endorse its zero interest rate policy in 2011, and the central bank may look to support the economy throughout the remainder of the year in order to stem the downside risks for growth. Indeed, the U.S. dollar lost ground following the release, with the EUR/USD rallying to a daily high of 1.4458, but the market reaction was certainly short-lived as the exchange rate ended the day at 1.4327.

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