NEWS / Foreign Exchange

4-year low ISM Overshadows Hostages Release News

Dollar extends pullback as the drop in US services ISM to a 4-year low is offsetting any upside reaction from Iran??™s decision to free the 15 British sailors. The fact that the much touted services sector is now joining its manufacturing counterpart into slowdown mode raises questions about the prospects of a soft economic landing.

The headline figure of 52.4 was the lowest since May 2003, while the employment index fell to 50.8 from 52.2, the lowest level since July 2004. We already saw the employment component of the manufacturing ISM dipping back into contraction territory at 48.7 to show 5 months below 50 out of the last 7 months. This augurs badly for Friday??™s payrolls, especially with the 3-month average in manufacturing, construction and services all heading lower. In fact, the 3-month average in services jobs fell to 173k, the lowest since August.

Now that the US economy is showing unequivocal signs of a slowdown, markets will seek a rise in the unemployment rate as the key to Fed easing. Thus, in the event that the jobless rate rises to 4.6% from 4.5% along with a payrolls remaining lower than 110-120K, markets will deem the report as an additional step to a June rate cut.

The data will further support the strength of the 119.20 resistance in USDJPY, and now calls up declines towards the 118.60s, with preliminary target standing at 118.40, but stability is seen at 118.00. The pace of USDJPY declines may pickup in the event that US equities sink into negative territory. EURUSD breaks above 1.3360 resistance, eyeing the key 1.34 barrier, which can be tested prior to Friday's payrolls. The dollar reterat coudl be intensified against European FX in the event the Bank of England raises rates tomorrow--which we do not expect. EURUSD upside seen remaining at 1.39, while GBPUSD remaining at 1.98. Our preferred trade remains EURGBP, with target at 68.00 from current 67.65.