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Tomorrow’s key fundamental release will be the ISM Non-Manufacturing index, a measure of the US services sector – which makes up about 85% of the economy.

Positive data can help give the USD some strength, as we would move one step away from the weaker growth seen in the 1st and 2nd quarters, one step away from the “temporary” soft patch that the US economy hit as a result of higher gas prices, Japan supply disruptions, and Greek sovereign debt concerns.

Manufacturing Rebounds in June

We saw the ISM manufacturing index climb in June, though much of the increase was led by inventory build up.

From Econoday: “Manufacturing is showing improvement at the national level according to the latest ISM report but a key question is what underlies the latest gain. The headline composite of 55.3 is 1.8 points higher than in May but inventories, one of five equally weighted components, jumped 5.4 points to 54.1. This reading could indicate restocking tied to prior Japanese supply shortages.  However, it may or may not indicate business expectations for improvement in demand. Order readings offer the best gauge on that and they are recently soft, with new orders showing only slight month-to-month acceleration at 51.6 compared to 51.0 in May.  But employers must be somewhat optimistic about future demand as employment is a big positive in the report with this index rising 1.7 points to a very strong 59.9. Input price pressure is severe but easing while production is steady at a moderately strong 54.5.”

Services Sector to Hold its Gains?

In the services sector, the main decline in the index came in March (57.3) and April (52.8), but already showed some signs of rebounding in May (54.6).

This is off the peaks we saw at the turn of the year, when the index was just below the 60 level in January and February.

Here’s a look at the breakdown of the May ISM Services report:

In May, we saw positive developments in new orders, employment, and new export orders. Let’s see if June can see further gains in those key sub categories.

Positive Scenario – Beat the expectations of 53.9, by 0.5 or more. That can have both the affect of improving the US fundamental picture, which is a USD positive, but can also carry dangers to the USD if it sparks risk appetite that favors higher yielders at the expense of the safe-haven USD.

The context of the market’s sentiment around the release can help guide us. If we are already seeing higher yielders gaining, then the report will support further risk appetite. However, if we come into the report with equities and sentiment weaker, then a positive print, while helping higher yielders to recover, can benefit the USD as it means the economy is on its way to recovering from the 2nd quarter slowdown.

With employment growth subdued however, it means less economic activity and less demand for services, which will likely temper any reading to the topside.

Bearish Scenario – A weaker than expected report, one in which we see a decline to 53 or below, opens up the case of risk aversion, falling stocks and a move out of higher yielders and into safe havens like the JPY, CHF, and even though it may be a US release causing the move out of risk, the USD.

Risk sentiment recovered from the negative news of Moody’s downgrading Portugal. However, if we add continuing weakness in the US economy to the mix we can see further “risk-off’ trading dominating.

Nick Nasad Chief Market Analyst FXTimes

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