How to Trade the US ISM Manufacturing Announcement

04/01/2009 9:47 am EST

Focus: FOREX

Manufacturing activity in the US is expected to contract for the 14th consecutive month in March as businesses face fading demands from home and abroad, however, the data could foreshadow a stabilizing market as economists forecast the ISM index to increase to 36.0 from 35.8 in February.

What's Expected

Time of release:  04/01/2009 14:00 GMT, 10:00 EST
Primary Pair Impact: EUR/USD
Expected: 36.0
Previous: 35.8

Impact of the US ISM Manufacturing Report on EUR/USD Over the Last Two Months

February 2009 US ISM Manufacturing
The ISM report showed that manufacturing in the US contracted for 13 consecutive months in February, but fell at a slower pace from the previous month as the index increased to 35.8 from 35.6 in January. The breakdown of the report showed new orders ticked lower to 33.1 from 33.2, while the employment component slipped to 26.1 from 29.9, which is the lowest since recordkeeping began in1948, and the data continues to foreshadow a deepening recession in the world's largest economy as the labor market deteriorates at a record pace. As households continue to face falling home prices paired with fading demands for employment, the outlook for private spending remains weak, and conditions are likely to get worse as firms continue to cut back on production and investment in response to the downturn in global trade.

January 2009 US ISM Manufacturing
Manufacturing activity in the US dropped at a slower pace in January after falling to its weakest level in 28 years during the previous month, and economic activity in the region is likely to remain subdued in the months ahead as businesses continue to face fading demands from home and abroad. The ISM index increased to 35.6 from a revised reading of 32.9 in December as new orders increased to 33.2 from a record low of 23.1 in the previous month. A deeper look at the report showed that new export orders increased to 37.5 from 35.5, while inventories slipped to 37.5 from 39.6, which is the lowest since July 2001, and conditions are likely to get worse throughout the first half of the year as the world's largest economy faces its longest recession in over a quarter century. As turmoil in the banking sector intensifies while the outlook for growth and inflation falter, the Fed is likely to step up its efforts as policy makers attempt to steer the economy out of a deepening economic downturn.

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 that 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 euro 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 EUR/USD 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 euro 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 EUR/USD ahead of the data release.

MORE: How to Trade This Event Risk |pagebreak|

Manufacturing activity in the US is expected to contract for the 14th consecutive month in March as businesses face fading demands from home and abroad, however, the data could foreshadow a stabilizing market as economists forecast the ISM index to increase to 36.0 from 35.8 in February. The final GDP reading for the fourth quarter showed that the world's largest economy grew at its slowest pace since 1982 as personal consumption, one of the biggest drives of growth, plunged 4.3% from the previous quarter to mark its worst slump since record keeping began in 1947, and business may continue to cut back on production and investments as private sector demands falter. As a result, factory orders fell for the sixth month in January as demands slipped another 1.9% after falling 4.9% in December, while wholesale sales plunged four times faster than stockpiles in January, and the data continues to emphasize the dire state of the economy as businesses slash their inventories at a record pace in an effort to reduce costs.

Moreover, industrial outputs in February plunged 11% from the previous year, which is the biggest drop since 1975, while vehicle sales slipped to 9.1M during the month to reach its lowest level since 1981, and households are likely to curb their temperament for spending as they face a weakening labor market. On Friday, we are likely to see the annual rate of unemployment surge to a 25-year high as non-farm payrolls are expected to fall another 659K in March, and the ISM's employment component could reinforce fears of a deepening downturn in the labor market if the gauge slips below 26.1, which is the lowest since the series began in 1948. Nevertheless, Fed chairman Ben Bernanke spurred hopes for a swift recovery during an interview earlier this month, stating that "the recession will probably end this year and the economy will expand in 2010" as policymakers take unprecedented steps to stimulate the ailing economy, however, the Organization for Economic Cooperation and Development said that the top 30 industrialized nations of the world will contract 4.3% this year, while forecasting a 0.1% decline in 2010, and going onto say that "macroeconomic stimulus is also critical to cushion the fall in aggregate demand as the downturn in the global economy accelerates."

Meanwhile, as G20 leaders hold a summit in London this week in response to the financial crisis, hopes for coordinated action by policymakers paired with support for a new reserve currency could weigh on the US dollar, however, if the group utterly fails to meet on common ground, a rise in risk aversion would bolster the greenback as it continues to benefit from its safe haven status.

Ongoing weakness in manufacturing favors a bearish outlook for the US dollar as growth and inflation falter, however, an enhanced ISM report paired with a rebound in the employment would certainly set the stage for a long dollar trade for the given event risk. Therefore, if the index rises to 36.5 or higher with all of the sub-components increasing, we will look for a red, five-minute candle following the release to confirm a sell entry on two lots of EUR/USD. Once these conditions are met, we will place our initial stop at the nearby swing high (or reasonable distance), and this risk will determine our first target. Our second target will be based purely on discretion, and we will move the stop on the second lot to break even once the first trade reaches its target in an effort to preserve our profits.

On the other hand, fading demands from home and abroad paired with expectations for further weakness in the global economy could weigh on business, and a drop in the index would lead us to short the greenback. As a result, if the ISM falls to 35.6 or lower, we will follow the same setup for a long euro/dollar trade as the short position mentioned above, just in reverse.

By David Song, Currency Analyst, DailyFX.com

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