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2,600.00 — The Financial World Is Watching You

2,600.00 — The Financial World Is Watching You

The title should speak by itself. We are fast approaching a make or break point in the S&P 500, and with the VIX running rampant above the 20.00 mark, I can’t envision bulls feeling too confident bottom-picking, even if a massive algo party is expected.

The Daily Digest is authored by Ivan Delgado, Head of Market Research at Global Prime. The purpose of this content is to provide an assessment of the market conditions for the next 24h of trading in order to assist one’s decisions on a regular basis. Follow Ivan on twitter.

Summary - 10 Dec 2018

The title of today's report should speak by itself. We are fast approaching a make or break point in the S&P 500, and with the VIX running rampant above the 20.00 mark, I can’t envision bulls feeling too confident bottom-picking the index. Brace yourself as major algo battle is expected.

If the level breaks, it could get ugly really quick, as the event is likely to induce a significant deterioration of the market psyche. We are teetering on the edge. Besides, no comfort can be taken from the latest activity by options traders on Friday, with high delta purchases of in the money puts keeping the downside bias intact, while out of the money puts at the 2,600 strike were also bought up to protect one's downside in case of a breakout. If a resolution south eventuates, it's like to be off to the races by a market caught short vega (vol), hence limited gamma scalping expected, which would only fuel the potential ‘arrivederci’ bearish run.

As you keep reading today’s report, even if I’ve placed plenty of emphasis in a plethora of macro/fundamental moving pieces, none makes it as high on the list as 2,600.00 in the ES. Volatility, as the VIX heralds, seems to be guaranteed. And it’s only going to get more exhilarating from here on out with the vote in the UK parliament of the dubious Brexit deal UK PM pulled off after endless negotiations with the EU. On Thursday, the ECB is also due, even if my sense and Danske Bank’s for this matter, align that Draghi will try to work out his magic by sounding vaguely non-committal to keep familiar ranges.

Overall, in today’s report, I rationalize the reasons that make me macro EUR bullish, the perilous tightrope the risk profile is currently going through (2,600 remember), why the Japanese yen appears well anchored for further gains (current valuation out of whack), oh, and before I forget, do yourself a favor by following Kai Pflughaupt on Twitter.

Market Drivers

  • The arrest of Huawei’s Chief Economist Ms. Meng, accused of fraud on the grounds of doing business with Iran, has sent shockwaves across the whole Sino-US relationship spectrum. Some rightfully question (I wouldn’t argue against) that the reasons for the arrest of who happens to be the daughter’s founder of one of China’s most powerful telecom companies lie on the suspicion of possible espionage through the company’s technology. Her arrest only reinforces the notion that the dispute between China and the US could be is far from being only on trade but about maintaining a dominant global position. Unless we see a satisfactory resolution and the release of Ms. Meng , it could debilitate the already fragile Sino-US relationship.
  • Ironically, as Beijing summons the US ambassador to demand an immediate release of Ms. Seng, the WSJ has published further details on the commitment of China to purchase US products as part of the ceasefire agreement or 90-day truce reached in G20. I think no one should be oblivious to the fact that Ms. Meng arrest, if anything, will cause this pact to be on shaky grounds. An indicator of my rationale? The outrage of China calling for her immediate release. Also, the reinforcement of China’s concerns that it’s not about trade alone but about the potential disruption of China’s strategic goals ‘Made in China 2025’.
  • It’s showdown time in the Brexit front. We are just one day away from the UK parliament voting on UK PM May’s Brexit vision via the compromise achieved with Europe. Based on all the headlines, it seems a fair statement to think the risk of not passing is highly likely. Also, we should, with all honesty, recognize that trying to guess where the Pound is going to be trading one week from now would be as hard as trying to find a needle in a hashtag. There are way too many variables to account for. Just look at the zillion of scenarios provided by The Times. Just mind-blowing. One thing is certain, brace yourself for volatility to kick in as imp vols suggest.
  • After 2 days of deliberations, OPEC agreed to cut production by 800k bpd (barrels per day) from the October levels. This is a number that falls short of the 1m bpd minimum threshold the market was hoping for. The cuts will take effect in Jan and last for 6 months. Will it keep Oil prices sustained and provide a bit of rebalancing effect the market needs? My first take is that it may provide a near-term circuit breaker around the $50 mark but it’s far from the number one would have wished to stimulate the outlook for global inflation via the volatile energy prices. No positives for the US yield curve here.
  • In Germany, Angela Merkel’s CDU party has elected Annegret Kramp-Karrenbauer (I know, it will take us all a few goes to get the pronunciation right but as a comfort, she goes by AKK, phew! ) as the Chancellor successor in the party’s leadership. This news, buried under a pile of other moving macro pieces, is huge, especially if she ends up at the helm of the German government. In issues such as the economy, strengthening the EU or maintaining strong ties with the US, AKK and Merkel are on the same page. The disagreement emerges in how they view the centrist and consensus-based style government.
  • The streets of Paris have been the scene of violent protests as thousands of so-called ‘yellow vest’ protesters took their anger to the streets in an act of defiance against Macron’s government and raise their voices against what they believe to be an unfair green tax. Even if the French Interior Minister told reporters that the violence in Paris was ‘under control’. By the way, do you think Trump stood quietly? He immediately tweeted about it, boasting the US decision to withdraw from the Paris climate change agreement. The unrest in the streets of Paris should hardly influence the pricing of the Euro near term. Here is a bird’s-eye view of the riots in Paris. Judge by yourself.
  • The mispricing of further US rate hikes into 2019, well telegraphed through the aggressive flattening of the US curve, is one of the market’s central focus. In the grand scheme of things, it should keep the USD on the backfoot as the fiscal-led sugar rush may also start to fade away. Leaving aside calls over the risks of a US recessionary cycle, which are well founded based on historical data and the late US business cycle, the market is now calling Dec rate hike as the very last one before the Fed goes into total data dependency mode. One can check out this handy tool via the CME group (Fedwatch) to understand the odds of further hikes.

Latest Fundamentals

  • In the US, Friday’s US non-farm payrolls number came below expectations. The headline number was especially poor, at +155k vs +198k, with the unemployment rate maintained at 3.7%, while the y/y wave growth also stood stagnant at 3.1%. The verdict by the market was to sell the US Dollar as it may lead to an extended period of a wait-and-see mode by the Fed. Questioning a Dec rate hike, even if the odds are moving lower from the 80s into the 70s percentile, would still be excessively daring judging by the state of the economy.
  • Last week was the Australian economy suffering a major setback to its monetary policy outlook after a terrible Aus Q3 GDP (household, consumption main culprits). Over the weekend, the raft of Chinese economic indicators painted an equally poor picture, which if anything, worsens further the outlook for the Aussie. The Chinese trade balance, both imports, and exports, showed a very worrying slowdown. Remember, China has more to lose than the US when it comes to the trade war, as trade figures between countries demonstrate. To make matters worse, the inflationary pressures out of China also disappointed over the weekend.
  • If you wanted to feel slightly more optimistic on the Australian rates outlook, the intervention by RBA’s Kent, the Assistant Governor for financial markets, would have probably appeased some fears. The policymaker affirmed that the next rate move is likely up, even if he left it unambiguously clear that it won’t happen anytime soon. The RBA put an overblown scenario?
  • Did you know that last Friday’s blockbuster Canadian employment report, comparatively, would translate in about 350-400k jobs creation in the US NFP? That’s how incredibly strong the number was, after a +94.1k change vs +10k. It was the highest reading as far as Bloomberg record go. And there certainly was meat on the bone, with the jobless rate down two ticks and the participation rate up by also two ticks. Wage growth wasn’t quite in line with expectations at 1.5% vs 1.8% y/y, but when all considered, I see the risks of the BoC backtracking its dovish tilt from last week after such a stellar report. Short AUD/CAD anyone? We’ll look into it later.
  • If you were to judge your views on the US economy by following critically important benchmark indicators such as the University of Michigan consumer sentiment, you’d be hard pressed to see anything other than an economy with its consumers still roaring ahead. Even if inflation expectations dropped, it shouldn’t come as a shock judging by the decline in Oil prices.
  • Last Friday, a Fed hawk as Ms. Brainard, reminded us that rate hikes remain appropriate in the ‘near term’. My interpretation of near-term is this December before Fed’s Chairman Powell overly emphasized data-dependency approach kicks in. On the opposite side, Fed’s Bullard, played his usual contrasting role by reiterating that leaves must stay unchanged.

Events Ahead

As its typical on Monday, there is an absence of relevant economic release. The UK GDP m/m and manufacturing production will be sideshows, only satiating the interest by algo-led or short-term traders but with absolutely no influence to the outlook for the Pound knowing what’s to come. Indeed, it will be on Tuesday when the plot will thicken dramatically in the Brexit front with the vote by the UK parliament of UK PM May’s highly dubious deal with the EU, which still casts many doubts. As the week progresses, the other key event comes in the form of the ECB policy meeting. Will Draghi & Co cave in to the underlying weakening economic pressures we are seeing in the Eurozone in H2? I will have much more to share as the week plays along. Also, be reminded that the same day the ECB meets, the SNB is scheduled to update its policy too. Another major event to monitor, even if one should not hold his breath, will be the US CPI on Wednesday. What the dramatic flattening of the US curve is telling us is that inflationary pressures are nowhere to be found nor expected. To end the week, the US will publish retail sales figures for the month of November.

Risk Model

Our prop risk-weighted index, with a drop of over 12% in the last 5 trading days, sends us the message to be on high alert as risk-off flow could return at any time. At present time, we are faced with a clear risk-off scenario, with the US Dollar caught in the crossfire as well, following the falls in the S&P 500, US yields, but as noted, also in the appeal to hold the world’s reserve currency.

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With a VIX above 20.00 points (23.23 last), wild 2-4% swings in any direction becoming the norm, a bullish gold as a vehicle to play defensive in stocks or a crisis brewing in US credit markets (HYG and IG), one must maintain a position of strong vigilance as the backdrop is far from soothing.

Where to next is anyone’s guess but we can certainly start to assess the ‘Ifs’ based on the scenarios we are being presented with. First of all, the S&P 500 is teetering on the edge of what could possibly be one of the year’s key technical resolutions if it breaks sub 2,600 - bottom of the multi-month range - . The closes in both the VIX and HYG suggests such eventuality runs a significant risk of materializing. In early Asia this Monday, the downward pressures on the ES futures are not abating…

What about US rates, in particular, the US 30-yr bond yield as a barometer of risk? It’s definitely entered an area of high interest circa 3.12%, which aligns with the midpoint of the previous 2018 range, and is reinforced by the intersection of the highest accumulation of volume (POC). What this means is that we’ve come to a level where a reversal of the bullish run in US rates could ensue.

What about the US Dollar index and gold for this matter? I am of the opinion that the US Dollar is set to go through a period of struggle and eventually break through its triangle pattern on the daily. Judging by the pick up in risk-off, buying the weakness is still a play that finds a fair rationale, as it’s the view that the triangle formation may still have a few more weeks until full maturity.

I just simply can’t envision nor justify higher valuation on the US Dollar as the US rates outlook stand. My view about the bearish tendencies for the US Dollar is being reinforced by the bullish resolutions seen in gold and in the Chinese Yuan as well. With some assistance by the ECB this week, which won’t place too much hope on for now, the US Dollar stance is in shaky grounds.

So, we are going to need US rates to find bidders of that POC to start building a case to sustain a more constructive picture, in hopes that the S&P 500 holds the range. Overall, expect the US Dollar to still trade within familiar ranges, with no resolution of 1.13-1.1450/15 levels ahead of the ECB.

As a consolation for those looking to bid risk this Monday, the lead one can take from the Japanese or US yield curves by the close of business last Friday is that long-dated bonds yields are performing slightly better than front of the curve yields (2y), which more often than not, tends to be a barometer to measure the market outlook heading into the next business day.

Forex Majors

EUR/USD: Valuation out of whack, eventual rate adjustment to 1.17

As the macro valuations stand, there is only one way I am betting this market to go, and that’s up. Go back any time in history, and you will realize that whenever we’ve had such a deviation between the pricing of the pair and the true value of the pair based on yields spreads, it almost always re-calibrates in favor of the yield spread, especially in the EUR/USD. Only in times of either a major event disturbing valuations such as the French election last year or risk sentiment flows, can cause such an anomaly in the pricing. Does this mean EUR will shoot straight up? Far from true such statement. But, it does suggest that at any opportunity available, this is a market that I am expecting will be loading on EUR shorts, trying to fade, deceive and manipulate traders, until institutions have accumulated enough size for what I believe will be a macro move into the 1.17. That’s where the EUR/USD is justified to be trading based on its yield spread, which is also aided by a stable Italian premium and even the breakouts seen in Gold or the Chinese Yuan.

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Access our daily levels selection

* These are the areas where the highest concentration of liquidity should be expected, therefore, areas to act as magnet where institutions will get involved in buy or sell-side business.

GBP/USD - Fasten your seat belt, it’s about to get wild

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As in the case of the E$, this is a market that should be trading significantly higher in line with a higher yield spread. However, it’s Brexit that will be driving this market. I’ve put together what I believe will be the most relevant liquidity levels to keep an eye on during the volatile events ahead.

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* These are the areas where the highest concentration of liquidity should be expected, therefore, areas to act as magnet where institutions will get involved in buy or sell-side business

USD/JPY: A major disconnect with true value, short accumulation eyed

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With the topside proving to be a tough nut to crack, an observation that is predicated in the 3 times that bulls have failed to break above a major weekly resistance area at 114.00-115.00, this market appears poised to trade much lower, especially on a breakout of the S&P 500 range. Even if not, one will be hard-pressed to justify higher levels by the dealing levels of both the US vs JP yield spread and the depressed risk-weighted index, justifying levels at or sub 110.00 in the pair. Technically speaking, the pair also remains in a fairly fragile position, capped by a descending trendline. Bottom line, look to lean on liquidity areas to engage in sell-side action. Even if technicals start to recover, I suspect that the loading of short positions at the test or break of upside liquidity will ensue.


Access our daily levels selection

* These are the areas where the highest concentration of liquidity should be expected, therefore, areas to act as magnet where institutions will get involved in buy or sell-side business.

AUD/USD: Poor risk-reward outlook to short the Aussie

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Even if the weekly chart shows a compelling bearish outside formation, the tapering of volume on the way down, coupled with the recovery in the AU vs US yield spread, suggests the fall may be ripped for a short-term recovery. If that’s the case, bulls must be aware that resistances will be found at unusually close intervals, which disallows much room for topside air pockets or void areas. The overall technical picture has been badly damaged as the market adjusts to worsening Australian and Chinese fundamentals. Today’s RBA’s Kent reassurance that rate cuts are not an option being considered could offer a bit of comfort, which could see a bit of a reprieve rally, subject to the risk environment as usual. Take as reference the levels provided above, as these are the areas where price will be attracted and repelled from. Overall, the risks remain skewed to the downside, with today’s bearish gap at the open a reflection of the buffeted sentiment towards the Aussie.

Access our daily levels selection

* These are the areas where the highest concentration of liquidity should be expected, therefore, areas to act as magnet where institutions will get involved in buy or sell-side business.


Options Market

Primer: When a futures contract shows heavy activity in IM Calls, that means that the holder of the call purchased has the right to buy the asset below its current market price, which implies that the right to buy that asset has intrinsic value. If we see strong IM Calls activity, that means institutional players/hedge funds/smart money are in a hurry to buy the asset for what they perceive could be a directional move brewing. However, the most frequent occurrences in options activity are changes in out-of-the-money Calls or Puts. Remember, an OM Call or Put would be an option that has no intrinsic value, but only possesses extrinsic or time value. As a result, the value of an out of the money option erodes quickly with time as it nears expiration.

Now, why do we want to check changes in OM Calls or Puts you may wonder? As I briefly touched on above, it is common practice by institutions, whenever they engage in a buy or sell campaigns, to use OM Calls or Puts for hedging purposes, as the cost of buying Calls or Puts out of the money are way cheaper than IM Calls/Puts (it acts as an 'insurance' against their desired direction). If we see strong activity in OM Calls, that generally means the market is looking to go directionally short and are using these cheap calls out of the money (at a higher level than current prices) as protection should the asset class eventually turn against their favoured directional bias (short). The opposite applies if we see a jump in OM Puts, this is communicating that the market's intention is more likely to be focused on long-side business in the underlying instrument.

The option activity is reinforcing my inclination to support EUR buys. Notice how OTM Puts are being trailed up from 1.12-1.1250 towards 1.13-1.1350? Meanwhile, OTM Calls (bought by shorts spot) remain intact at the heavily populated 1.15 strike with a slippery area afterward til 1.1650. In other words, players looking to buy cheap insurance via OTM Puts to protect long spot are raising their dynamic stops via OTM Puts. In my experience, this is a bullish macro signal since strikes to protect downside and upside are both being trailed up in line with the bullish macro valuations I pointed out.

What’s more, Friday’s EUR/USD options activity in the new front contract, shows more aggressive IM Calls, to the tune of 993 vs only 96 IM Puts, with the Calls covered via OTM Puts at a ratio of 1:1 vs OTC Calls. The changes should be yet another layer of bullishness to be factored in. A similar occurrence suggests the USD/JPY pair should come under increased pressure, as IM Calls in Japanese Yen futures double down by about 450 contracts.


What about the British Pound? Ahead of the Brexit vote on Dec 10th, the current open interest in the 6B weekly futures reveals significantly higher protection topside 1.32-1.3250 BUT most bang for one's buck (ratio 2:1) continues to be for those playing longs judging by options positioning. The area of 1.2550 reveals where most OTM Puts were bought, which currently gives about 230p of downside potential, while the highest concentration of OTM Calls lies at 1.3250 (~450p of upside potential).



In the heavily traded E-mini S&P500, last Friday’s numbers reveal institutions piling onto IM Puts quite aggressively as 2,600 comes into focus. In total, last Friday we saw the addition of over 2,641 new IM Puts, which only adds to the downside pressure as it heralds a short bias market. On the contrary, more and more downside protection is being added via the buying of OTM Puts at 2,600.00. There is a huge open interest of nearly 50k contracts worth of OTM Puts at the bottom of the S&P 500 range at 2,600.00, which is going to arguably be, by a fair margin, the level most watched in the whole constellation of assets classes around the globe. Also, be aware that implied volatility in the S&P 500 is running rampant, way above its historical average, which means a market with tendencies to short volatility (vega), hence any breakout may force unhedged Put sellers having to buy puts to protect their unlimited downside risks, which may act as an accelerant of the downside move.



Banks Intelligence Gathering

Since I didn’t touch on the Kiwi this morning, I will let ANZ provide us with an update on the flying Kiwi, which continues to defy gravity in what they call a perfect storm for the currency.

Below is the latest take by Morgan Stanley on the state of affairs in the USD. Their perma bear call remains undeterred, making the following connections. A stronger Yuan leads to broad USD weakness -> foreign capital to migrate to the East -> risk in the outlook for the US inflation and growth -> Long EUR, JPY, BRL vs USD best way to play their views.

Can’t wait to get your hands on the first ECB preview. Danske Bank published his outlook last week, noting that the central focus could be on the reinvestment strategy, with an overly cautious Draghi, in hopes that his intervention will minimize the impact on the Euro valuations.

Today's Twitter Shoutout

This weekend, as I was scanning through the latest market news, I came across Kai Pflughaupt, who goes by the handle name @MacroTechnicals in Twitter. Kai is an InterMarket Analyst, Former Institutional Rates & Credit Trader. Honestly, it’s just outrageous the amount of value one can obtain out of his tweets, especially when he goes on his typical weekend “Global Markets Recap” rampage. I’d best define his twitter feed as a constant tsunami of hidden gems. You better do yourself a favor and click that ‘follow’ button. He spreads proper financial literacy like few I’ve seen.

Here is a spoiler:

And that’s just like 1 out of a zillion tweets he puts out as part of its ‘Global Markets Recap’.

Quote of the Day

Steve Burns ‏@SJosephBurns: “Taking losses is an underappreciated trading skill. Keeping them small compared to your wins. Or just surviving them emotionally if they are big.”

Like What You See?

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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.
  • 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 highlight that the daily market outlook provided in this report is subject to the impact of the fundamental news. Any unexpected news may cause the price to behave erratically in the short term.
  • Projection Targets: The usefulness of the 100% projection resides in the symmetry and harmonic relationships of market cycles. By drawing a 100% projection, you can anticipate the area in the chart where some type of pause and potential reversals in price is likely to occur, due to 1. The side in control of the cycle takes profits 2. Counter-trend positions are added by contrarian players 3. These are price points where limit orders are set by market-makers. You can find out more by reading the tutorial on The Magical 100% Fibonacci Projection
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