US-EU Trade War Escalation Hits Risk Sentiment

It’s been a rough start of a new quarter for the likes of equities, both in Europe and the US, as concerns over global growth after the decade-low print in the US ISM must now co-exist with heightened tensions of a trade war between the US and the EU. The Japanese Yen was, alongside the New Zealand Dollar, the main beneficiary.

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. You can also subscribe to the mailing list to receive Ivan’s Daily wrap.

Quick Take

You wouldn't have guessed it was a true 'risk-off' environment out there as the EU-US trade war escalates by analyzing the performance of the NZD and the CHF. The former ended up as the main winner, only surpassed by the perky Yen, while the latter succumbed to a depressed inflation print out of Switzerland, which increases the risk of further negative rates by the SNB. Again, risk sentiment matters as much as fundamentally-derived flows. But the NZD performance is one I still scratch my head. The utter evaporation of longs in the CAD off fresh yearly highs is also quite an X-file to ruminate about, without much of a particular catalyst other than the fall in Oil prices, which in my opinion, does not justify the annihilation of CAD longs. The USD saw solid demand right off the gates in Europe, but gave it all back as capital flows entered in the US. Meanwhile, both the Euro and the Sterling were well underpinned by demand flows, the latter driven by the subtle positivism so far around UK PM's plan to solve the Irish backstop. Last but not least, the most volatile currency on Tuesday, the Australian Dollar, saw slow fluctuations as the short-side interest dries out after its overextended move.

The indices show the performance of a particular currency vs G8 FX. An educational video on how to interpret these indices can be found in the Global Prime's Research section.

Narratives In Financial Markets

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

Equities suffer the consequences of EU-US trade war escalation: It’s been a rough start of a new quarter for the likes of equities, both in Europe and the US, as concerns over global growth after the decade-low print in the US ISM must now be co-exist with heightened tensions of a trade war with the US at the center, this time against Europe after a WTA ruling, partly expected, allowing the US to impose tariffs on EU products.

WTO ruling in favor of the US deepens risk aversion: The WTO ruled that the US can go ahead imposing tariffs worth over $7bn in EU products, including wine, whisky, luxury goods and aircraft in retaliation for the loss of business by Boeing due to illegal EU aid to Airbus. The US is set to impose retaliatory tariffs of 10% on EU aircraft, and 25% on EU agricultural, industrial goods. The measures are set to take effect on Oct 18. Authorities in Europe have been quick to react, noting that this strategy is likely to be responded with counter tariff measures by the EU.

The US ISM PMI set the ball rolling: The US is seen as one of the ultimate safe harbor out there, still immune to the debilitating macroeconomics elsewhere, but the recessionary reality in the manufacturing sector coupled with aiming to fight a fresh trade war with Europe while fully immersed in trade dispute with China is a major red flag. 

Watch today's US ISM non-manuf PMI: The US ISM-non manuf PMI is set to be a big market mover as a more important proxy of the state of the overall economy in the US, given that the services industry represents a larger share of the economy. If the last print in August serves as an indication, the sector continues to thrive for now.

US ADP data not a good omen for the US economy: A soft print in the US ADP private sector payrolls, coming at +135K in September vs 140k expected, alongside a downward revision to 157k from 195k threw more cold water. The market now awaits the US NFP report on Friday in order to gather new evidence on the state of employment in America, one of the bedrocks of the economy so far.

JPY the unquestionable winner as stocks/yields drop: The depth of the fall in bond yields and stocks is what led to the acceleration by the Japanese Yen index, which has capitalized on the positive technicals after the breakout of a long-held range on the back of the US ISM miss. 

Low Swiss inflation raises alarm bells for further negative rates: The Swissy, even if seen as a funding currency set to perform well amid risk aversion, has been lagging way behind, as the Swiss inflation in September missed median estimates by coming at the lowest in almost 3 years. Depressed inflation and the macro strength in the Swiss national currency increase the risk of further negative rates by the SNB.

Fed's Williams in neutral camp: Fed's member Williams crossed the wires, saying that monetary policy is in 'the right place', which implies he is in neutral territory, even if the market now sees the chances of the Fed funds cut in October at 74% chance vs 60% last Friday.

GBP receives tentative positive news: The GBP has continued to trade in an erratic and non-directional fashion despite the fact that UK PM Boris Johnson revealed his plans for the Irish backstop. In a nutshell, Johnson proposes that Northern Ireland remains compliant with EU rules with some checkpoints away from the border still in place as a special temporary arrangement for four years before the Northern Irish parliament determines if the arrangements are to be extended.

UK PM Brexit plan 'up in the air': The plan was welcomed by the DUP and Brexiteers but Irish PM Varadkar said the backstop proposal didn’t fully “meet the agreed objectives”. Meanwhile, EC President Juncker sounded neutral, noting pros in his comments such as that the proposal contained “positive advances” but at the same time, noting it had “some problematic points”. The EU Summit on October 17th looms near and that’s when the GBP will be most volatile.

Stay glued to the Brexit newsflows to get a bias on the Pound: However, according to Verhofstadt, a Belgian politician, the reaction of most MEPs to UK proposal was "not positive" ahead head of the Brexit steering group in European parliament, even if the reporter added that they will discuss it more in the days ahead.

Recent Economic Indicators & Events Ahead

Source: Forexfactory

A Dive Into The FX Indices Charts

The indices show the performance of a particular currency vs G8 FX. An educational video on how to interpret these indices can be found in the Global Prime's Research section.

The EUR index successful rotation off the lows was always going to make it riskier to endorse shorts with a high degree of conviction as dip buying activity could very well be expected, and eventually, that’s what has transpired. We haven’t had to wait long for the market to make up its mind that the path of least resistance into the US NFP (36h away) is to the upside. The acceptance of higher levels into the NY close, alongside the 2nd leg up, supports the notion that the cycle is now in that prime state where a 3rd leg up should ensue. On the way down, it will require a drop of 0.2% or 0.4% roughly to expect the highest concentration of bid clusters.

The GBP index continues to find relentless demand interest off the daily support area drawn in red. If you were to engage in long-side GBP exposure every time the index nears the area, your plays would have had a high chance of being successful every single time. That’s how power power lies in assessing the potential demand imbalances on an aggregate basis vs G8 FX. To the downside, any revisit of the daily support will likely continue to be bought, while engaging is GBP shorts carries a higher risk due to twofold. Firstly, because the last swing low failed to rotate back to the previous low, and secondly, because a daily support area is now in control.

The USD index attracted strong demand off the daily support line drawn 24h ago, which means those entering long USD vs the weakest projected currencies such as the CHF, would have had a field day indeed. The failure to retest the prior swing high does not invalidate trading off the daily support, but you want to be patient until at least there is a break as the market will then be given a chance to enter long with deeper liquidity available. Should the support be broken, the next one is found over 0.3% lower, hence it could also be a bearish day for the USD if initial acceptance is found below the daily support right underneath.

The CAD index has come under exceptional sell-side pressure with the decline in Oil alone not really justifying the overextended depreciation in the currency. Demand in the CAD is expected to emerge within close proximity of the current price, anywhere between the current level and 0.2% lower, where a major daily support in the context of a successful rotation will be found. To the upside, we should wait patiently until the creation of a new resistance area, not yet visible, due to the impulsive and rapid depreciation of the currency index.

The NZD index should see renewed sell-side pressure at a level of resistance identified in the 8h chart, which makes Wednesday’s correction a potential selling opportunity into Thursday, especially considering the successful rotation achieves off the last swing high currently tested. The proximity of the baseline right overhead adds to the bearish case. Matching up short NZD against a currency expected to find demand nearby is the way to go. The downside potential also looks quite attractive, with over 0.6% until a retest of the trend lows.

The AUD index is closing in into a sell-side resistance area off the hourly chart, followed by a daily resistance not far above (0.15%). The dovish outlook by the RBA makes the Australian Dollar a clear candidate to experience further sell-side pressure, as it is the deterioration in risk sentiment ever since the US ISM PMI, now exacerbated by the EU-US trade war escalation. Allowing the AUD to keep correcting higher only to be prepared to engage in shorts against currencies with expected demand to be found is the way to go, similar to the picture in the NZD.

The JPY index has shot up past the 100% proj target, which means the probability of a rotation back down towards areas of demand is rather high. It certainly is for the brave with momentum-type strategies to be deployed jumping on such an elongated movements. It’s worth noting that the initiation of the aggressive buy-side campaign on Wed came off an outlined support line on the 8h chart. If you are a value-seeking trader, allowing the JPY to deflate from its lofty levels it trades at before giving considerations to engage in long plays is a sensible approach. The 100% proj is an excellent tool to anticipate when a swing is overcooked and has the highest chances of temporarily terminating, and that’s what where the JPY trades at.

The CHF index trades in between demand and supply areas after being hammered on the back of a miss in the Swiss CPI. The successful leg down allows us now to draw key levels of resistance on the way up, which will require first for the Swissy to correct significantly higher. On the downside, there is a daily support area over 0.5% under today’s close. It essentially makes the Swissy a non-tradable currency in the near-by vicinity amid the lack of levels definition.

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. 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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