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USD Weakness In A Macro ‘Risk On’ Dominant Theme

USD Weakness In A Macro ‘Risk On’ Dominant Theme

Anyway you slice it, be it from a day-to-day or even stepping out from a weekly standpoint, the Sterling is by a country mile the outperformer in the FX arena as the ‘hot’ period of Brexit plays out.

Date: 2/27/19

The Daily Edge is authored by Ivan Delgado, Market Insights Commentator at Global Prime. The purpose of this content is to provide an assessment of the market conditions. The report takes an in-depth look of market dynamics, factoring in fundamentals, technicals, inter-market, futures and options, in order to determine daily biases and assist one’s decisions on a regular basis. Feel free to follow Ivan on Twitter & Youtube.

Quick Take

Anyway you slice it, be it from a day-to-day perspective or even stepping out from a weekly standpoint, the Sterling is by a country mile the outperformer in the FX arena as the ‘hot’ period of the Brexit deadline plays out and vol picks up. In the last 24h, only the likes of the Aussie has been able to keep up a similar upward pace, even if only in relative terms during the later stages of Tuesday (US session). On the flip side, the US Dollar is the main loser after the most recent crossflows activity on the back of a rather uneventful testimony by Fed’s Chairman Powell in front of the Senate Banking Committee, where he reiterated very familiar themes.

A bunch of other currencies such as the Loonie, the Kiwi, the Euro or the Yen traded more subdued. This latter basket of currencies, excluding the JPY (NZD, AUD, EUR, CAD) exhibit trendless dynamics from a weekly standpoint as the flat slopes of the 5-DMA on the 2nd window below reflects. Meanwhile, this same thick lines still portray a market that is overall negative on the JPY and USD, more so on the latter, as the JPY recovers from recent lows as the slope of the cross line (25-HMA) reflects.

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Narratives in Financial Markets

  • Fed’s Chairman Powell, in a testimony in front of a Senate Committee, repeats familiar themes by noting that this is a time for the Fed to be ‘patient’ on policy, which he further clarified as the Fed being in no rush to make judgment on monetary policy near term.
  • It also came to my attention the release of the Fed discount minutes, with all 12 voting members showing a consensus about keeping rates unchanged during the January FOMC. The signals sent by the Fed couldn’t be clearer in terms of ‘wait and see’ stance on rates.
  • After Monday’s tweet by US President Trump, when he attempted with a fair degree of success to talk down Oil prices, OPEC+ sources note that the cartel is looking to stick with its current quotas and push for further adherence. Essentially, OPEC+ is dismissing the hints by Trump.
  • A raft of US economic indicators was released on Tuesday. We saw a strong Feb consumer confidence reading, The Richmond Fed manuf index for Feb also came upbeat at 16 vs 5 exp, as did the Philadelphia Fed non-manuf index at 10 vs 1 prior. These were the bright spots. On the downside, US Dec house price index came marginally lower, but even worse was the US Dec housing starts at 1078k vs 1256k exp, further evidence of the weak demand in housing.
  • The Sterling continues to be the star currency as UK PM May told MPs that if the existing withdrawal agreement gets rejected in coming weeks, the parliament would then have the power to decide on the binary outcome of voting to leave the EU on March 29th without a deal in place or alternatively, vote for an extension of Article 50. The market has unquestionably latched on the idea that kicking the can down the road by delaying Brexit is a short-term positive outcome for the Sterling as it removes an immediate risk. Uncertainty is very high.
  • During Tuesday’s Inflation Report Hearing, BoE Governor Mark Carney made no particular headlines, simply re-phrasing well-known talking points about the overall health of the UK economy even if it remains highly conditioned to the cross-currents of Brexit. The fact that Carney mentioned that in the event of a worst-case Brexit, the Central Bank stands ready to provide stimulus and liquidity to support banks and the economy was reassuring.

Economic Indicators/Events Ahead

Source: Forexfactory

RORO - Risk On Risk Off Conditions

In the last 24h, the common denominator in the ‘risk on, risk off’ model is market dynamics characterized by a debilitated USD in the broadest sense, as US yields from the short to the long end of the curve sell-off in tandem (bonds up), while gold prices also capitalize on the USD fragility. This USD weakness in the short-term is combined with mild negative flows in equities as reflected by the downward slope in the 25-HMA.

As a result, in the short-term, we find ourselves in scenario #6 of the RORO model, in which clues to gauge the risk directions should be obtained via equities. If the sp500 moves lower, the risk environment remains not friendly overall. However, under this context, the USD weakness, indirectly, eases pressure on emerging markets and may keep the likes of beta currencies underpinned, as long as the declines in the equity domain occur in a context of contained vol.

From a macro angle, the dynamics are still ‘true risk on’ as the slope of the 5-DMA (125-HMA) reflects. Overall, the dominant tendencies of a weaker JPY, USD against beta currencies are still the main play to be aware of according to the findings of the model.

Dashboard: Intermarket Flows & Technical Analysis

A resolution of the week-long range has been found by the Euro finding enough of a demand imbalance to accept multiple hours of auctions in the pricing above 1.1370. The extension higher has been fairly limited in nature as the 1.14 round number has acted as reliable resistance for now. With technical and intermarket measures all pointing higher, at this stage looks like shorting this market carries higher risk as per the measures monitored in the table above. It’s worth noting that as the macro correlation coefficient shows, the 10y German-US yield spread has been a great leading indicator to guide us in the fair value of the pair. As such, with both micro/macro slopes derived off the mentioned yield spread pointing upwards, the buy-side pressure should remain solid.

The market that has manifested the greatest demand/supply imbalance in the last 24h is the Sterling vs the US Dollar. With the slopes of technicals and intermarket studies showing us the way higher, there is absolutely no reason to believe we shouldn’t be expecting higher valuations. If you are incorporating intermarket studies into your methodology of trading the markets, be reminded that in recent times, as the correlation coefficients show, the GBP/USD has become a function of two markets (DXY + UK vs US bond yield spreads), with the correlation as high as it can possibly get. Buying on dips strategy to capitalize on USD weakness seems a sensible strategy, with this approach obviously conditioned to Brexit headlines still being supportive for the Sterling (critical).

The recent supply of JPYs came to an abrupt halt against the US Dollar, as the combination of lower US yields and a higher EUR/USD (lower DXY), led to a major bearish outside day in USD/JPY. The aggressive turnaround has translated in all short-term measures (technicals _ intermarket) to turn negative. However, with the macro slope of the SP500 and the US 30y bond yields still exhibiting an acute upward angle, coupled with the oversold nature of the move in the hourly chart, this is a market that looks like it could end up being rotational as significant clusters of bids should still populate the books given the relatively high value thatexistst buying as oversold market when highly correlated assets, especially the SP500 these days, is still on a macro bullish trend. That said, as reiterated in several occasions, due to the broad-based USD weakness, there are better currencies to pick (AUD, GBP, NZD, EUR) if you wish to exploit a potential resumption of JPY supply imbalances.

On the Aussie, the short-term picture remains quite benign, with the micro technical trend endorsing the notion of higher levels ahead. On the intermarket front, the recent recovery in the AU-US bond yield spread also promotes the idea of an adjustment in valuation to the upside. If we see the Yuan picking up momentum in line with its dominant trend, this is a market that looks quite constructive for buy-side strategies to thrive amid the optimistic macro ‘true risk on’ environment. Be aware that if your style is more swing/day trading, we have entered overbought conditions as per the slow stochastic, which suggests setbacks would be most welcomed to increase risk reward prospects.

The synchronized movements lower in Oil (inverted) and DXY have led to what might potentially result in a full rotational move back to test the most recent trend lows. If this scenario eventuates, one should notice that at the present time, the pair enjoys sufficient near-term technical/intermarket factors to make a solid case for this hypothesis to play out. With the DXY so depressed at oversold levels, it’s really going to depend on whether or not Oil can continue to recover further ground. From a macro perspective, the 5-DMA slope is still supportive as well, which adds to the odds of the central scenario playing out.

A market that is in a temporary holding pattern for the last 3 days is gold. If you pay attention to the most correlated instrument macro wise, you’ll notice it’s all about the direction of the US02Y bond yield (inverted), which is a proxy for the Fed Funds, in order to gauge the next direction. Judging by the spike in this instrument, alongside a battered USD as a logical consequence, Gold is a market that appears to be setting up for an eventual break higher. This is a market that so far has displayed an immaculate bullish trend, hence any period of balance area is probably serving the purpose of further long-side accumulation before the next markup in prices.

With the RORO model indicating a near-term environment dominated by USD weakness in a context of falling equities in the last 24h, we are going to need a turnaround in the SP500 futures to give us the confidence necessary to reinstate long positions in the AUD/JPY. Assuming the US30Y bond yield in the US remains pressure, if that occurs while the DXY sells-off, we can continue to temporarily dismiss yields and just keep our attention on the direction of equities to gauge the next direction. Remember, the macro outlook is still broadly supportive of higher prices. Be prudent as Asia opens, since the pair closed NY in overbought conditions. See setbacks as potential buying opportunities.

The EUR/UAD market has been much more contentious without displaying a clear direction. However, in the very near term, the dynamics are underpinning the Euro to a greater degree based on the strongly correlated German-Australian bond yield spread as well as lower equities. On the contrary, a strong Yuan, especially due to DXY demerits, keeps the upside capped. On top of that, the 5-DMA slopes, which gives us an idea of the tendencies in the last week, still show the SP500 and the Yuan promoting lower valuations, while the bond yield spread, which remains the strongest correlated instrument, hints that the path should be higher. Overall, this is not a market with an easy ready as there are conflicting elements contradicting each other. When that’s the case, a more erratic, rotational behaviour in price fluctuations is a real possibility. In other words, if you trade this market, be prepared to potentially expect range-bound conditions near term.

Last, the NZD/USD is looking strong amid shallow pullbacks in the currency pair. The market structure is bullish and so are the dynamics in the DXY and the NZ-US bond yield spread, even if the latter still shows a macro divergence as per the flattish macro slope. With the dominant theme being the weakness in the USD, the downside looks very limited near term, with buying on dips preferred.

Important Footnotes

  • Risk model: The fact that financial markets have become so intertwined and dynamic makes it essential to stay constantly in tune with market conditions and adapt to new environments. This prop model will assist you to gauge the context that you are trading so that you can significantly reduce the downside risks. To understand the principles applied in the assessment of this model, refer to the tutorial How to Unpack Risk Sentiment Profiles
  • Cycles: Markets evolve in cycles followed by a period of distribution and/or accumulation. The weekly cycles are highlighted in red, blue refers to the daily, while the black lines represent the hourly cycles. To understand the principles applied in the assessment of cycles, refer to the tutorial How To Read Market Structures In Forex
  • POC: It refers to the point of control. It represents the areas of most interest by trading volume and should act as walls of bids/offers that may result in price reversals. The volume profile analysis tracks trading activity over a specified time period at specified price levels. The study reveals the constant evolution of the market auction process. If you wish to find out more about the importance of the POC, refer to the tutorial How to Read Volume Profile Structures
  • Tick Volume: Price updates activity provides great insights into the actual buy or sell-side commitment to be engaged into a specific directional movement. Studies validate that price updates (tick volume) are highly correlated to actual traded volume, with the correlation being very high, when looking at hourly data. If you wish to find out more about the importance tick volume, refer to the tutorial on Why Is Tick Volume Important To Monitor?
  • Horizontal Support/Resistance: Unlike levels of dynamic support or resistance or more subjective measurements such as fibonacci retracements, pivot points, trendlines, or other forms of reactive areas, the horizontal lines of support and resistance are universal concepts used by the majority of market participants. It, therefore, makes the areas the most widely followed and relevant to monitor. The Ultimate Guide To Identify Areas Of High Interest In Any Market
  • Trendlines: Besides the horizontal lines, trendlines are helpful as a visual representation of the trend. The trendlines are drawn respecting a series of rules that determine the validation of a new cycle being created. Therefore, these trendline drawn in the chart hinge to a certain interpretation of market structures.
  • Correlations: Each forex pair has a series of highly correlated assets to assess valuations. This type of study is called inter-market analysis and it involves scoping out anomalies in the ever-evolving global interconnectivity between equities, bonds, currencies, and commodities. If you would like to understand more about this concept, refer to the tutorial How Divergence In Correlated Assets Can Help You Add An Edge.
  • Fundamentals: It’s important to highligh
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