Posted on: 11 Feb, 2019
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The Daily Edge 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. 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.
The ‘risk-off’ regime we’ve gradually transition into since mid last week still remains in place, with some minor signs of abating via equities not yet providing enough technical evidence to shift the focus back to bid risk. Unless the equity bounce is backed by yield curves or a significantly weaker DXY, I wouldn’t read too much into the late US equity rally as to single-handedly be able to revert the fortunes of what’s an otherwise still cloudy outlook.
In today’s write-up, I argue in favor of a potential continuation of the JPY strength against selected currencies such as the EUR or the AUD. Similarly, amid this environment, commodities such as Oil should go through a hard time. If global equities resume the rollover, it will take us back into micro-macro ‘risk-off’ flows back in alignment, likely to support USD, JPY, Gold.
Narrative In Financial Markets
China is back from holidays, that’s why it will be critical to follow very closely the performance in the Yuan as a continuous barometer of the trade negotiations alongside the Shanghai Composite/CS300.
The overarching key story ruling markets continues to undoubtedly be the China-US trade negotiations. The rhetoric has turned progressively negative since last week, with the cancelation of the Trump-Xi meeting the last straw to see an increased interest to go ‘cash’ and play more defensive.
That’s why this week’s trade talks will be, as has been the case, highly critical to monitor even if the complexities involved suggest these are talks that are most likely going to go down to the wire, hence no breakthroughs are eyed short-term.
In the UK, we get growth and manufacturing data as a sideshow to Brexit.
From a microflows standpoint, the late rebound in the S&P 500, even if it has turned the slope of the 25-HMA upwards, does not carry enough credence for one to latch on and conclude that constructive ‘risk-on’ conditions are set to extend much further. The main reason is predicated on the basis that the rebound occurs in the context of a newly found bearish macrostructure in the S&P 500 as per the downward slope in the 125-HMA (5-DMA).
Additionally, the rest of the risk assets monitored as part of the model are far from sending us the right signals to support risk trades. We are faced with a backdrop in which the DXY shows little signs of slowing down its bull trend, while the US 30-year bond yield continues to move downhill.
Even more worrisome, Gold has decoupled from its negative correlation with the DXY by printing gains on Friday even as the USD rose. Whenever this happens, the market may be anticipating trouble ahead by diversifying into gold as a shelter to protect against a wave of deleveraging risk.
Overall, the pre-conditions are far from ideal to support a sustainable ‘risk-on’ environment. The combination of movements can be understood, from a micro perspective, as ‘weak risk-off’ in nature, which is wrapped within a broader context of a ‘true risk-off’ market profile.
The environment continues to be dominated by deteriorating bull flattener dynamics, which should add to the notion that the environment is far from constructive to lean on risky currencies.
With the exception of the Canadian Dollar, which saw its yield curve improve a tad, the rest of G6 FX are all caught up in a downward spiral of anticipatory lower growth and weak inflation.
What this means is that this environment, if anything, worsens the outlook for the market to recover back its mojo and I’d expect the JPY and the USD to fare quite well against beta currencies.
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In light of the negative risk backdrop expected, one would expect the JPY to be well positioned to capitalize on the weakest currencies. On my radar, I can think of two in particular (EUR, AUD). The former looks particularly attractive from a technical standpoint, as the current rebound is faced with a plethora of converging bearish technicals such as the rest of a broken resistance-turned-support circa 124.35–40, a downward sloppy 25-HMA, coupled with a tap into last Friday’s POC. The trade would be negated should the market structure of lower lows gets violated by a breakout of the 124.70–75 level, in which case, a re-assessment of the conditions will be required.
Buyers continue suffocated by the selling pressure ignited ever since Feb 4th. While in the last early stages of the bear rally the trend developed in a non — volatile orderly manner, the last 2 trading days we’ve seen buying flows coming in with more impetus. Regardless, attempts to regain control above the previously highlighted critical 1.1350–60 have failed with each corrective leg up being weaker in magnitude (35p followed by 28p). With the 1.1325 low now taken out, the next focal point is likely to be 1.13 round number. Any rebounds will face pressure technical pressure emanating from momentum traders given the slope of the 25-HMA. Similarly, a descending trendline off Feb 4th high alongside Feb 7, 8 POCs overhead suggests further clusters of offers ahead that may limit any rally and still make it corrective in nature with the market eyeing 1.13, where significant buying pressure is a real possibility judging by the major divergence with the yield spread. Also note, the mentioned psychological level is a perfectly symmetrical target as a 100% measured move from 1.1512–1.1405.
Technically speaking, there is still a case to be made for the Sterling to find buying interest off 1.2925–30 horizontal support. The latest BoE-induced spike breaking above the previous structure high at 1.2970–75 does offer some offer some technical credence that implies demand is re-emerging. Buyers need to hold this critical line at 1.2925–30 from which the rate should be lifted up towards the 1.2970–75 to keep re-calibrating the technical into a more neutral stance. However, be reminded that any rebound would still be trading into negative flows originating from correlated instruments such as the DXY or the UK-US yield spread, both supporting further declines.
The market is currently experiencing its most prolonged low vol phase in 2019. The lines of battle have been clearly defined on both sides, with the weekly horizontal resistance in red having acted as an excellent anchor point to define the midpoint of the current phase of consolidation. By analyzing the behaviour in USD/JPY’s most correlated assets, the latest rise in the DXY + SP500 does support the buying on dips mentality for now, while the major divergence with depressed US yields does also suggest that any retest of 110.00 and beyond should find increasing sell-side interest in light of such macro divergence with what’s arguably been, according to the correlation coefficient in the 3rd window (in green), the most correlated asset in recent times. At this point, there are only 3 key areas to be involved from an hourly perspective (110.00–110.10, 109.85–90, 109.55–65).
The first tentative technical cracks of the bearish trend are starting to be observed, as buy-side flows have resulted in the breakout of a short-term descending trendline. A retest of the area of resistance at 0.7115–20 would allow for the market to transition into a range from 0.7060–65 up to 0.7115–25. As the correlations stand, the weakness in the Australian-US bond yield spread, alongside the bullish momentum in the US Dollar, should keep supply pockets fairly strong as the pair correct higher. The recovery in the S&P 500 in the last 24h has arguably assisted the rebound off lows, but with domestic factors (yield spread) playing a more important role for the Aussie, and as the correlation coefficients suggest, it’s the yield spread and the DXY+Yuan we must pay special attention to.
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