Markets Sell Off As China Retaliates

As China bites back retaliating by imposing tariffs on US goods effective by June 1st, the markets are coming to grips that such actions, even if not tit-for-tat, it means that we are in the midst of discounting a prolonged rhetoric war period.

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 in order to determine daily biases and assist one’s decisions on a regular basis. Feel free to follow Ivan on Twitter and Youtube.

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Quick Take

As China bites back retaliating by imposing tariffs on US goods effective by June 1st, the markets are coming to grips that such actions, even if not tit-for-tat, it means that we are in the midst of discounting a prolonged rhetoric war period between the two countries, with fears of tensions escalating even further. As a result of the re-evaluation of the new dominant trade thematic, and judging by the punchy moves in the Yen or equities, the market seems to have still a lot to re-price. As I will elaborate in today's report, the RORO model paints an ailing picture in risk assets, both from a micro and macro standpoint, finally re-invigorating vehicles of diversification such as Gold. Commodity-linked currencies, with the CAD no exception as Oil and risk off weights, are feeling the pain of the current dynamics of a battered Yuan, while the Sterling also take a hit as a function of the appeal to bid back the US Dollar across the board, excluding against the Yen. The Euro continues to find firm pockets of demand against most currencies.

Narratives In Financial Markets

* The Information is gathered after scanning top publications including the FT, WSJ, Reuters, Bloomberg, ForexLive, Institutional Bank Research reports.

  • ‘True risk off’ returns with a vengeance after China retaliates the US by raising tariffs to 25% on $60bn worth of US goods from June 1. The tariffs fall way short of what China will have to bear in the latest round of tariff hikes by the US, seen as China aiming to take a moderate response as the priority remains to leave a door open for an eventual trade deal.
  • The actions taken by the Central Bank of China (PBOC) so far, also suggest that China is playing a soft hand for now, hoping to leave the door open for a deal. The decisions made by the PBOC to fix the CNY stronger in the last fixings, hence widening the spread between the onshore CNY and the offshore CNH, communicates they won’t let the trade crisis blow up.
  • As part of the retaliation, China is also mulling to stop the purchase of some US agricultural products and energy, restrict Boeing orders and US service trade. The retaliation by China means that the situation is heating up and the markets are understandably unsettled.
  • Proof of the sour mood in markets, even if the US Secretary of the Treasury Mnuchin made an attempt to talk up markets by stating that China trade talks are still ongoing with a trip to Beijing being planned, the markets this time didn’t buy into it.
  • Timme Spakman, Economist at ING, notes “the US has threatened to raise additional tariffs if China were to retaliate. With that, the risk of further escalation is far from over. If the US were to expand its tariff measures, China is expected to continue to retaliate in a similar mild fashion. This, because it is difficult for China to retaliate with equal measures since China imports a lot less from the US than the other way around. With its mild response, China also maintains the moral high ground in the conflict.”
  • A market to continuously monitor very closely is the Chinese Yuan, which has depreciated by more than 2% ever since the tariffs threat by Trump the first weekend of May. Further weakness in the Chinese currency is an indication that the market is pricing in, if anything, a prolonged and arduous process before the US-China can ink a trade deal. Capital flights from China are causing the currency to come under increasing sell side pressure.
  • A Trump tweet reinforces the notion that the US and China have reached a serious impasse. Further talks yielding any significant progress perceived as dead in the water near term. A prolonged delay before a deal is potentially inked is the scenario the market is discounting, which is why ‘risk off’ keeps deteriorating. Trump wrote that “China will be hurt very badly if they don’t make a deal because companies will be forced to leave China for other countries. Too expensive to buy in China. You had a great deal, almost completed, and you backed out.”
  • China said that they will never surrender to foreign pressure. If anyone had still doubts, these type of comments pretty much sum up that at this point, no side is backing off from their hard-line stance when it comes to what they perceive as non-negotiable aspects.
  • US Trump says China cannot take advantage of the US any longer, that plans are being made to meet with Chinese representatives at the G20, and that no decision has been made yet on tariffs worth another $300bn of Chinese goods. Trump also played down the capacity of China to retaliate against the US, noting that their actions are limited against the US.
  • Tensions in the Persian Gulf are increasing after two Saudi Oil tankers were attacked on Sunday, which has led to the US beginning air patrols around the peninsule. There is no responsibility claimed on the perpetrators of the attack, with Oil very volatile, initially boosted by the incident, only to sell off as risk off conditions picked up in the US.
  • The escalation in the US-China trade tensions alongside the soft US CPI last Friday has led to fixed income players to strengthen their conviction that the next rate move by the Fed will be a rate cut after the US 1y Treasury bill fell below the Fed funds rate. However, Fed’s Chair Powell has made the case that near-term inflation is transitory, hence raising the bar.

Recent Economic Indicators & Events Ahead

Source: Forexfactory

RORO (Risk On, Risk Off Conditions)

The risk environment keeps deteriorated further as the rampant movement in the JPY clearly indicates. The acceleration in the selling of US equities (S&P 500 as reference) or the buying of long-dated 30y US bonds as news broke out of the Chinese retaliation to the US triggered a sustained cascade of supply imbalances across risk-sensitive assets. The late-day recovery in the DXY, while the JPY holds onto its strong gains, is further evidence of investors truly moving past the diversification into any currencies other than the historically risk off choices such as JPY, USD. The ‘true risk off’ scenario is not only manifested through all the micro trends monitored in our RORO model, but these day-to-day fluctuations are in congruence with the macro tendencies too, as the sentiment and modeling are rapidly turning very bearish amongst bigger hedge fund managers. The Chinese Yuan keeps acting as one of the best barometers to evaluate the levels of fear by a protracted trade war between the US and China, with the speed of the Yuan depreciation not abating; the USD/CNH market is fast approaching the 7.00 handle, a massive psychological level to watch. Meanwhile, with a VIX snapped back above 20.00 and junk bonds in free-fall, it goes full circle in registering one of the most negative RORO model readings this year, in accordance with the level of surprise that signifies the US and China moving further away from what was seen as a deal baked in the cake just 2 weeks ago. The reality is that the market is discounting a scenario of a prolonged delay in the US-China trade negotiations/deal, which carries a severe adjustment in valuations as investors anticipate a major setback for global growth in the 2nd semester of 2019. One can read the scenarios I had considered as part of the US-China trade negotiations in the following link.

Latest Key Developments In FX (Technicals, Fundamentals, Intermarket)

EUR/USD: PoC Keeps Acting As A Magnet

The rotational nature that comes with the printing of a single volume profile formation played out as anticipated as part of Monday’s price action, where an impulsive buy side campaign led to what eventually became a head fake through 1.1250. Notwithstanding the determination of sellers to kick the rate away from its highs all the way to levels near the lowest since May 9th, the conditions are still considered as range-bound with 1.1230-35 the most heavily traded area 2 days in a row. This signifies a very clear clue that the market is only finding value at a neutral level for buyers and sellers, hence why there has been a tendency to fade the edges as part of a single distribution playbook. It’s going to take a break and hold beyond the extremes of the range to shift the focus away from range trading.

GBP/USD: Range Breakout With Acceptance

The ferocious move away from Monday’s highs was in line with the rotational features of trading a single profile market structure as suggested in yesterday’s note. The regular selling that came through the books in this exchange rate has led to the onset of a new bearish cycle, one in which I’d expect any correction to be capped by the POC of the last 3 days just above the 1.30 round number. The shift to a bearish trend in the OBV (On Balance Volume) is a sign that the sell-side volume pressure carries significant committed capital, further reinforcing the case to sell on strength.

USD/JPY: Sell-Side Bias, Volume Builds At Trend Low

Whenever we see such a clean breakout of a prolonged range, with the volume profile that follows a double distribution down with most of the volume at the very lows of the trend, that’s a sign that as long as buyers fail to build a similar amount of acceptance at higher levels today, any correction should be perceived as a selling opportunities. The areas of most interest to engage in sell-side action where the most accentuated supply imbalanced could be found will be the usual levels I tend to promote (50% fib retrac, retest of the former range bottom, midpoint range). Intermarket flows, both the DXY and the risk profile (SP500 + US30Y) remain very restrictive for any sizeable upside correction, hence overextension that leads to a change of bias is not the base scenario.

AUD/USD: Bears In Control As Yuan Weakness Extends

The combination of ‘true risk off’ markets and the overextension in the Yuan downtrend were music to the ears of sell-side accounts, who managed to end the day with a victorious double distribution volume profile. As in the case of the USD/JPY, we’ve seen an awful lot of volume accepted at the bottom side of Monday’s full extension, which tells us more pain ahead. It really is the worst background possible for the Aussie, which has the extra negative of facing no economic indicators out of Australia or the US to potentially act as risk events that disturb the downtrend in place. In terms of intermarket flows, keep following the formula in the 3rd window as the number 1 leading indicator of the exchange rate, with so far no indications that the tide will turn bullish anytime soon.

Gold: Protection Against Pick Up In Risk

The price of gold has exploded straight into the 100% measured target as US-China trade escalations are expected to dampen the outlook for global growth and the appeal towards stocks takes a hit. Amid this environment, gold becomes a substitute and historically viable vehicle of diversification. The double distribution up day , with the price closing at the absolute maximum level with the POC left behind is a very solid indication that engaging in buy side business is the way to go. There is a genuine chance that the market may resume the uptrend on the retest of the POC or thereabouts, as it’s a rare occurrence to see such a n aggressive buy side volume profile pattern, which basically translate in a market where sellers have run to the exits in mass as buyers pile in.

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 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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