Posted on: 07 May, 2019
There is no doubt that the fluid state of affairs in the US-China trade negotiations after Trump’s aggressive tactics is casting a long shadow in financial markets. But before diving into this new potential conundrum for markets, today’s RBA monetary policy decision, has caused quite a spike in the Aussie after the policy rate was left unchanged at 1.50%.
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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 & Youtube.
There is no doubt that the fluid state of affairs in the US-China trade negotiations after Trump’s aggressive tactics is casting a long shadow in financial markets, one that is leading to a major re-evaluation of capital allocations as reflected by the punchy jump in vol on Monday. But before I dive into this new potential conundrum for markets, today’s RBA monetary policy decision, has caused quite a spike in the Aussie after the policy rate was left unchanged at 1.50% amid split market expectations of circa 50% chances of a cut today. The status quo by the RBA acts as a positive near-term input for the Aussie, even if the ability to sustain today's gains must be reconciled with the new chapter we’ve entered in the US-China trade negotiations. The depreciation of the CNH towards 6.80 after breaking a multi-month stable range is a red flag that poses the following question: Are we really at the end of proceedings of a US-China trade deal or is the market preparing for a new beginning characterized by a break away from the trade truce? If the latter, it will likely lead to a potential new regime of a lower Yuan valuation to offset the increase in tariffs and with it, higher vol in FX. But this scenario still comes with some big IFs, so we should for now, keep monitoring the news. Acting as a circuit breaker is the positive development that China’s trade representatives are still headed to Washington this week to resume the trade talks with their US counterparts as the threat of tariffs hangs over if they don’t agree to the US demands of not re-negotiating laws of IP and proprietary technology. In terms of currency performance, the Japanese Yen has been the major beneficiary of the shift in risk flows, while the USD trades steady even if its performance on the face of ‘true risk off’ is underwhelming, and to make matters worse, the analysis of USD pairs is not painting a great picture either.
Trump’s off-the-cuff drastic change in language towards China has sent shockwaves across financial markets and without a doubt, is the theme all valuations in asset classes depend on now. In retrospect after 24h of price discovery, US markets bought into the idea that such threats by Trump are part of his own tactics of negotiation, whereby he aims to add pressure to China by doubling down his aggressive approach in order to get the desired trade deal conditions.
The market was always well aware that Trump’s tweets to hike China’s exported products and services to 25% on $200bn this Friday were a calculated gamble that may have backfired if the China trade delegation had decided to cancel this week’s trip to Washington for a resumption of the trade talks. However, the confirmation that China is set to attend the meetings, including the attendance of the top trade negotiator Liu He has definitely acted as a temporary circuit breaker. This news led to a temporary punchy recovery by US equities, leading to a significant pullback in the VIX to 15 from levels as high as 19.00 in the last Asian session, when the market went into panic mode.
The situation remains very fluid nonetheless, as reflected by the sharp leg down that has followed the retracement in US equities at the close of business in New York, which has come hand in hand with another boost towards the Yen. The deterioration in risk post-US market hours comes after a media briefing by US Secretary Mnuchin and trade representative Lighthizer, which left no doubt that the US is serious about hiking tariffs on Chinese imports this Friday.
Friday’s threat about the US imposing a hike in tariffs to China is as real as it gets. It has the market obviously worried, which is why this is an important period of re-assessing capital allocations as the US makes clear that it isn’t willing to renegotiate any previous points in the agreement as China intended, especially in laws aimed at ending the enforcement of US companies when it comes to sharing proprietary technologies and other intellectual properties.
Trump has let the cat out of the bag by expressing his discontent towards the tricks China intends to play as part of the trade negotiations. The sizeable moves from Monday have now changed the market perceptions on an outcome that the market thought was all but done and dusted. The disconnect between last week's talk-up of positive developments on a trade deal with China by the US and muted price action was a communication that the event had been pretty much fully discounted.
Whenever that’s the case, the market sees the event as no longer a driver (fully priced). Therefore, we are left with little options in which US-China trade headlines can move the needle in any significant manner by promoting a boost in vol again. The public upset by Trump signifies a 180-degree change from expectations, which makes uncertainty go haywire as fears of a no deal or at least a significant delay in proceedings is an event the market was not prepared for.
Whether or not the US and China continue to exasperate markets and financial conditions get tighter, in other words, we see a resumption of ‘true risk off’ dynamics, is going to be a balanced act of calculating the pros and cons by both ends. In the end, no side wins by not inking an eventual agreement. However, these hiccups we are experiencing this late in the negotiations phase were truly unexpected and the reason the markets have had to re-adjust.
By scanning through some of the trade-related reports from China, the prospects of breaking away from the current trade truce appear to be an event some factions of the Chinese ruling-party might consider bearable. If one takes a look at the USD/CNH, up about 0.8% after breaking its Feb-April range, there is definitely a message being sent here: The market is in a high alert mode that a no-deal scenario can transpire, increasing CNH outflows. If one takes a look at the Shenzhen or the Shanghai Composite, down a whopping 7.4% and 5.1% respectively on Monday, that’s again, quite a telling story about how a no deal is a scenario no longer ruled out.
Shifting gears, the RBA left rates unchanged at 1.5%, and even if this time the playbook indicated a close call of 50:50 in everyone’s playbook following the deterioration in Australia’s CPI, the Central Bank has decided to still remain on hold while it matures its easing bias. With the Australian elections in 2 weeks time, and with the emphasis still very much on the stubbornly firm labor market, the RBA is still giving themselves some extra room even if not acting in the near future amid lower inflation prints may undermine their credibility as part of the mandate is to maintain stability in prices. Rather than being opportunistic in inflicting further pain on the AUD, the RBA continues to apply its usual thoughtful wait, even if economists are starting to question why the Central Bank is so slow in making what seems to be an inevitable easing move. This Friday’s SoMP (Statement on Monetary Policy) will shed a light in what’s expected to be a downgrade in inflation, growth and tentatively unemployment.
The risk conditions have clearly permuted into ‘true risk off’ after the Trump tweets shocker of the weekend. Both the micro and macro trends in US equities and the US bonds, as reflected via the slopes of the 25-HMA and 125-HMA, indicate that the deleveraging process is ongoing. Surprisingly, the weakness in risky assets is yet to be translated into a stronger USD, which it may partly have to do with the unwinding of carry trades, which results in bailing long USD positions, hence creating selling pressure across the board in the immediate aftermath of such a punchy move in the VIX towards 19.00, The days of ultra-low vol FX may be behind us, especially if the USD/CNH keeps its steady pace north, which is going to be very much dependable on an eventual trade agreement. The strong rally in the Japanese Yen, nonetheless, is yet further evidence that one cannot be complacent betting for a further recovery in risk, at least, that’s not the message the market is sending us. The lead European markets can obtain from the performance in China after the massive plunges yesterday alongside the reaction of Japanese markets today, back after the Golden long-week, will be key.
EUR/USD: Balanced Flows Keeps Range Intact
The exchange rate has been confined in a narrow box, with clear symmetrical patterns to be drawn in helping us identify the key levels of interest heading into Tuesday. To start off, be aware that within the range, the Euro is finding a firmer footing, with a marginally higher high printed, which has been followed by a retest and rejection of Monday’s PoC after a sequence of volume tapering. Also notice, the accumulation of volume activity ever since the US NFP release last Friday is notoriously bullish as the thick orange OBV lines reflect. The positive dynamics in the Euro hinge on the ability of the currency to break and accept above 1.12-1205, in which case 1.1220-25 will be targeted in alignment with the 50% proj target ahead of the 100% proj at 1.1235. On the way down, if the bullish structure within the range is disrupted by sellers regaining Monday’s PoC, then 1.1175-80 will come into focus, with a break lower exposing the first sellers’ target at 1.1163 ahead of 1.1150.
GBP/USD: Renewed Buy-Side Campaign Underway
Following the stellar impulsive run in the Sterling off 1.30 post the US NFP, the market went through a period of a corrective move in nature, which stopped on its tracks at the confluence level of 1.2985, which aligns with the 50% fib retracement + horizontal line. The volume profile has seen most of the volume activity concentrated around the 1.3080 level, in the context of a bullish structure, hence why I see this consolidation as an opportunity for an accumulation of further longs. What this means is that a re-take of 1.31 would give us the signal that suggest buyers are back in control as the short-term sellside dynamics fail to keep up amid the violation of the bearish structure. Furthermore, the re-take of 1.31 round number in Asia coincides with buyers leaving the 25-HMA behind, while the OBV indicator, which gives us an idea of volume pressure, turns north too above its micro average line. The upside resolution through 1.31 is reinforced by the volume setup, whereby the latest attempt to explore lower levels occurred in very low volume activity, only to be followed by buy volume spike. Overall, the pair is setting up for a resumption of the uptrend, which if the thesis holds true, is likely to create opportunities to play momentum trades in line with the main bullish trend.
USD/JPY: Sellers In Control Of the Trend
Indications in early Asia suggest the intraday chart is controlled by sell-side accounts, with the evidence in price action mounting as the re-opening of the Nikkei shows negative momentum, allowing sellers to retake the 25-HMA. This deterioration in sentiment has also been translated in the value line accounting for the S&P 500 futures and US bond yields finding a new leg lower, alongside a lower DXY, which justifies the bearish bias based on intermarket flows. When looking at the volume profile, the accumulation of volume on the topside has been followed by a successful swing down in price, which reinforces the notion of trapping late buyers on the exchange rate. When analyzing the aggregated volume via the OBV indicator, we can clearly see the tick activity has shifted towards the downside, which indicates sellers are applying greater pressure. As part of this context, where the OBV is below its 25-HMA, we’ve also witnessed an M formation in volume, which tends to lead towards a retest of lower levels. Overall, the market looks poised to find follow-through sell-side interest for a retest of 110.50-60 ahead of more aggressive targets into the 110.30 and 110.00 round number.
AUD/USD: RBA-Led Spike En Route To 0.7050-60
The explosion in the Aussie on the back of an RBA hold has taken the exchange rate into the 0.7050 after breaking through the 100% proj target of 0.7030. What this means is that the next target buyers will aim for can be found between 0.7055-60, which is the 200% proj target and multiple highs through late April. The strong volume activity has seen the OBV transition into firmly positive territory, with the first 30m candle print post the RBA setting the bullish bias for the rest of the day, even if one must be aware that with the US-China trade relationships as a clear risk factor and with the ADR limit surpassed, the scope for further upside this Tuesday should stay rather limited beyond 0.7060. Any setbacks on the exchange rate should see most demand concentrated between 0.7025-30 ahead of 0.7000-05, which if all else equal, can genuinely represent solid short-term buy-side opportunities.
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