Trading the News: How to Trade the US ISM Non-Manufacturing Composite Announcement

11/05/2008 11:35 am EST

Focus: STRATEGIES

The US service sector is expected to contract after expanding for the last two months as the world's largest economy heads into a recession. Economists predict the ISM Non-Manufacturing index to fall to 47.2 from 50.2 in August as fears of a global meltdown intensify, and conditions may only get worse as service-based activity accounts for more than three-quarters of GDP.

What's Expected
Time of release:                  11/05/2008 15:00 GMT, 10:00 EST
Primary Pair Impact :         EUR/USD
Expected:                           47.2
Previous:                            50.2

Impact the ISM Non-Manufacturing Composite Has Had on EUR/USD After the Last Three Months

September 2008 US ISM Non-Manufacturing Composite

Service sector activity in the US expanded for the second straight month, but grew at a slower pace as the ISM index inched lower to 50.2 from 50.6 in August. A deeper look into the report showed that prices paid fell for the fourth straight month to 70.0 from 72.9, while new orders increased to 50.8 from 49.7. Furthermore, export orders unexpectedly jumped to 50.5 from 44.5, but the downturn in the global economy may weigh on demands over the coming months as the major economies throughout the world find themselves in troubled waters. Moreover, the employment component edged lower to 44.2 from 45.4, which suggests that domestic demands may remain subdued throughout the rest of the year as labor demands falter.

August 2008 US ISM Non-Manufacturing Composite

The ISM non-manufacturing index unexpectedly improved to 50.6 from 49.5 in July on the back of falling oil prices. The summary of the report showed that the prices paid component declined for the second straight month to 72.9 from 80.8, while new orders increased to 49.7 from 47.9. Meanwhile, export orders fell for the fourth consecutive month, to 44.5 from 47.5, which was followed by a decline in the employment component to 49.7 from 51.9. Despite the surprising improvement in the headline reading, ongoing weakness in the labor market paired with fading demands from the global economy could weigh on the economy, which could lead the Fed to lower the benchmark interest rate in the coming months as growth prospects deteriorate.

July 2008 US ISM Non-Manufacturing Composite

Services in the US contracted for the second consecutive month despite an unexpected increase in the ISM index to 49.5 from 48.2 in June. A breakdown of the report showed that new orders slipped to 47.9 from 48.6, while export orders plunged to 47.5 from 52.0. In addition, the prices paid component declined to 80.8 from 84.5, while the employment index pulled back from a seven year low as it jumped to 47.1 from 43.8. Despite the downturn in domestic and foreign demands, lower oil prices may help firms to cope with the slowdown in the economy, and could lead the Fed to drop their hawkish outlook as growth prospects deteriorate. The FOMC has held a neutral policy stance as they held the benchmark interest rate steady at 2.00%, but may opt to ease policy over the coming months as the downside risks to growth increase.

How to Trade This Event Risk

The US service sector is expected to contract after expanding for the last two months as the world's largest economy heads into a recession. Economists predict the ISM Non-Manufacturing index to fall to 47.2 from 50.2 in August as fears of a global meltdown intensify, and conditions may only get worse as service-based activity accounts for more than three-quarters of GDP. The advanced growth reading for the US showed that the economy contracted 0.3% in the third quarter, while personal spending slipped 3.1% to record its biggest decline in 28 years. Increased fears of a severe downturn have certainly weighted on the private sector, as retail spending fell 1.2% in September, followed by a bigger than expected decline in domestic vehicle sales. In addition, fading demands from the domestic economy and from abroad led firms to cut back on production as the ISM Manufacturing index plunged to 38.9 from 43.5 in September to reach its lowest level since 1982. Meanwhile, the employment component of the ISM report slipped to 34.6 from 41.8, indicating that economic activity may weaken further as employment opportunities falter. The ongoing weakness in the labor market, paired with fears of a prolonged recession, could lead the FOMC to lower the benchmark interest rate further despite the extraordinary measures taken by Fed chairman Bernanke. Fed funds futures are showing that there is a 54.4% chance that the MPC will opt to lower the key rate by 50 bp to 0.50%, while there is a 45.6% chance that the central bank will reduce borrowing costs by 25 bp to 0.75%. As expectations for another potential rate cut remain favorable, the US dollar could face increased selling pressures in the months ahead as the proactive Fed continues to hold a dovish outlook.

Trading the given event risk may not be as clear cut as some of our other trades, but nevertheless, a surprising improvement in the service sector would stoke bullish sentiment for the greenback. Therefore, if the ISM release beats expectations, we will favor a bullish dollar trade, and will short the EUR/USD. Following the release, we will look for a red, five-minute candle to confirm an entry on two lots of EUR/USD, and will place our initial stop at the nearby swing high (or reasonable distance). The initial risk will be set equal to our first target, and our second target will be based on our discretion. Once the first trade reaches its target, we will move the stop on the second lot to break even in order to preserve our profits.

Conversely, a downturn in services would only heighten growth concerns for the US, which would spur increased selling pressures for the reserve currency. As a result, a decline in the ISM index would certainly favor a bearish dollar trade (long EUR/USD), and we will follow the same setup for the short position as the long state above, just in reverse.

By David Song, Currency Analyst for DailyFX.com

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