By DailyFX - US capital markets were facing an interesting situation Thursday. A strong rebound in the ISM manufacturing survey the day before and heightened...

... sensitivity to the payrolls release due the following day left the traders in the theoretical valley of volatility.


On one hand, the rebound in Wednesdays factory report generated
expectations for a similar surprise in its services counterpart. Instead, the
markets received a near spot-on print of a modest cooling for the sector. As
volatility traders backed away from the market, fundamentalists acted upon the news.
Service-based businesses account for nearly 90 percent of the economy, so the
deceleration in expansion tarnished one of the remaining pillars of growth. At the
same, a November pending home sales raised a caution flag. The indicator failed to
support the unexpected rebound in both existing and new home sales for the same
month. Though mortgage inventories look to be topping out, sales are peaking into
positive territory and the NAR is forecasting a bottom will be in place sometime in
2007, investors are visibly hesitant in prescribing to a rosy outlook. This
fundamental mix easily carried Treasuries higher, but the equities and the dollar
were less pliable. The limited reaction in the other two markets was due to the
looming NFP report tomorrow, which has been built up thanks to buzz surrounding the
shocking ADP number yesterday.

Bonds - US 10-Year Treasury Note

Offering the biggest move for the day, the Treasury market responded to the
otherwise tame data with surprising interest. In fact, government bonds were on the
move after the very first economic release hit the wires this morning. Initial
jobless claims for the final week of December offered the final puzzle piece for NFP
forecasts. First time claims through December 30th picked up more than expected to
329,000 people. After the shortfall in the Hudson Employment index, the Monster
Index and ADP private payrolls numbers, the claims data is only irritating an open
wound. Following the increase, the T-note advanced 3/32nds to 99-26. The next step
up for the debt instrument came after the ISM non-manufacturing release. While
traders were prepared for a volatile surprise, the 57.0 print was sufficient enough
to instigate another bounce higher. With services cooling, the overwhelming theme in
the market for the Fed to finally start cutting can come back to the forefront and
effectively put an end to the nearly month-long decline in treasuries through
December.

FX - EUR/USD

The US dollar posted a mixed reaction to the mornings ISM Services data, as an
initial drop gave way to later strength. Judging by the immediate sell-off in
equities and drop in bond yields, markets broadly construed the ISM report as weaker
than expected. This was not visible from Greenback trading, however, as the dollar
remained relatively bid through the afternoon. In fact, the past two days of rallies
have been enough to send the US Dollar index to its highest close since its
late-November tumble. Clearly, foreign currency markets took a much more sanguine
look at the Services sector report. What remains to be seen, however, is whether
this is a clear sign of a bullish turn or simply a function of closing out
positions.

Outlook on the Greenback will clearly depend on tomorrows economic data, with the
all-too-influential Non Farm Payrolls report due at 13:30 GMT (08:30 EDT). Though
signals leading up to the release are largely bearish, todays ISM Services data
actually improves outlook on the national labor market. The closely watched ISM
Services Employment index gained in the month of December, falling just short of the
fourth quarter high at 53.6. Given its close relationship with NFP reports, the ISM
figure actually puts risks to the upside for recently downgraded consensus forecasts
of the December employment change.

Equities - S&P 500 Index

Equities saw another volatile day of trade, as a strongly negative reaction on this
mornings economic data forced the S&P 500 to yesterdays lows. Bearish momentum
seemed short-lived, however, as a later reversal on falling energy prices pushed the
index 0.1 percent higher on the day. With oil prices at fresh 18-month lows, a rally
in industrial shares led US equities broadly higher despite tumbling Oil Share
prices. Overall implications for tomorrows economic data seem mixed, however,
with no clear picture on how stock markets may react to the Non Farm Payroll report.
Unlike the US dollar, domestic equities could actually weaken on a
stronger-than-expected NFP print. As such, the later S&P 500 reversal could actually
hint at a bearish outlook for the labor market with the potential to leave the US
dollar lower in its wake.


Regards,

John Kicklighter
Forex Capital Markets
32 Old Slip, 10th Fl
New York, NY 10005
Email: jkicklighter@dailyfx.com

FXCM and its affiliates assume no responsibility for errors, inaccuracies or
omissions in these materials. They do not warrant the accuracy or completeness of
the information, text, graphics, links or other items contained within these
materials. FXCM and its affiliates shall not be liable for any special, indirect,
incidental, or consequential damages, including without limitation losses, lost
revenues, or lost profits that may result from these materials. This email is not a
solicitation to buy or sell currency. All information contained in this e-mail is
strictly confidential and is only intended for use by the recipient. All e-mail sent
to or from this address will be received by the FXCM corporate e-mail system and is
subject to archival and review by someone other than the recipient.