Watch ISM as a Leading Indicator for Payrolls (page 1 of 2)

DailyFX Fundamentals 03-30-07

By Kathy Lien, Chief Strategist of DailyFX.com

US Dollar - In an unexpected twist, what should have been a relatively quiet Friday turned out to be an extremely volatile one. As we expected, the Chicago PMI only triggered a limited reaction in the currency market. Despite a strong 14 point rise in the Chicago PMI index, traders questioned the reliability of the jump because it comes in sharp contrast to the weakness that we have seen in the Philadelphia Fed and Empire State manufacturing surveys earlier this month. Although the Chicago PMI report has had a stronger correlation than the Philly Fed with the national ISM index since 2005, over the longer term, the Philly Fed tends to be the more reliable leading indicator for the ISM. Furthermore, the Chicago number has been faulted for sharp spikes and false signals in the past, which suggests that predicting next week's ISM number is anyone's game. Most of the strength came from a sharp rise in new orders and production and since both the employment and prices paid components of the report fell, there is still underlying weakness. Other reports released today were mixed with the PCE deflator and construction spending increasing while consumer confidence deteriorated. Personal spending accelerated from the prior month while personal income growth slowed, indicating that consumers continued to spend more than they earned, which is not a healthy habit. However despite the abundance of US data released today, it was not the US economic reports that drove the significant volatility in the currency and stock markets. Instead, the US Commerce Department announced that they will impose tariffs on Chinese exports of glossy paper for the first time in over 20 years. The dollar sold off on the announcement on fears of retaliatory measures by China and the impact brought on by protectionism. Our special report about the US Sanctions on China - Will there be more to Come? explores this topic even further. In the week ahead, manufacturing, non-manufacturing ISM and non-farm payrolls are the most important US economic releases due for release. The employment components of both of the ISM reports will be used as leading indicators for Friday's payrolls number, so expect some volatility in the markets should there be any surprises on that front. In the meantime, it is important to look for any responses from China because in all likelihood, this could be the first step towards more sanctions.

Euro - Strength in the Euro today was driven purely by the news on China. The most logical retaliatory measure for China to take, if they were to take one would be to announce that they plan on diversifying a part of their big war chest of foreign exchange reserves away from the US dollar. In that case, one of the most immediate beneficiaries would be the Euro, which has long been chipping away at the US dollar's status as the world's premier reserve currency. There were no major surprises in Eurozone data last night. German retail sales growth on a monthly basis was right in line with expectations, but the annualized pace of spending fell more than expected. The rest of the data was relatively positive with French GDP and producer prices firming, the Eurozone CPI estimate increasing, the regional unemployment rate dropping and overall confidence improving. In the week ahead, Eurozone PMI indexes are due for release along with regional PPI, retail sales and German industrial production. US data should dictate trading however since both the US ISM and non-farm payroll reports are the foreign exchange market's biggest market movers.