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Nov 12: The outlook for risk turns ugly quite rapidly

Nov 12: The outlook for risk turns ugly quite rapidly

Authored by Ivan Delgado, Head of Market Research at Global Prime. The purpose of these institutional-level chart studies 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.

Fundamentals: Break down of market drivers + key releases

Since market auctions last Friday, the plummeting of oil has been a key focus, as the prospects of a pick-up in inflation sink in the process. Even more pressing and as a consequence also exerting strong downside pressure on the Sterling, are reports that a Brexit deal is coming apart as that last mile to agree on the Irish border continues to be a challenge that cannot be overcome.

A headline from the Sunday Times sums it up, noting that “Theresa May’s Brexit deal crashes as EU ‘turns off life support’”, outlining that Brussels has rejected May’s latest proposal to reach a compromise. The commentary that perhaps embodies the renewed pessimism like no other came courtesy of the UK International Trade Secretary Liam Fox, touting the possibility of leaving the EU without a deal after all.

Boris Johnson, Former UK Foreign Secretary also kept voicing his concerns writing in the UK Telegraph over the weekend, noting that the UK is on the verge of total surrender in the Brexit negotiations.Heading into Monday, one must be reminded that we get public holidays in both US and Canada, which will obviously affect the liquidity available.

Risk model: The picture has turned ugly quite rapidly

Let’s dissect what are the risk conditions heading into Monday. First of all, I’d like to first highlight the hammering in value witnessed in our prop risk-weighted index as a result of classic ‘risk-off’ flows, which means lower equities, lower yields, and higher DXY. Interestingly, despite the malign conditions, Gold is behaving as a function of USD performance once again vs a ‘risk-sensitive’ vehicle.

As the structures in equities, yields and the DXY stand, we seem to have transitioned into mild ‘risk off’ conditions owed to not only the upside resolution in the DXY as a proxy for ‘risk aversion’ but I am also accounting for the potential development of a new down-cycle in the US 30-year bond yield if we can get back-to-back hourly closes sub a critical daily support area at 3.39%. If this materializes, let me clearly state that this is not a good recipe for risk at all. We’ve already seen the order flow dynamics bid up US bonds (lower yields) while the DXY heads higher, that’s why I emphasize that if a structural break lower in US yields comes amid USD strength, that’s the clearest sign yet of a pick up in ‘risk off’ flows, independent of how equities perform. Obviously, the lower equities head amid the above premise (higher DXY, lower US30Y), the worse it will get.

The hope for contrarian traders is that equities can find support, which short -term is not a scenario to rule out as the S&P 500 tests an important hourly support. The rebound will need to come in tandem with a recovery in US yields though. There are a few warning signs coming from the S&P 500 chart though. The latest push up failed short in magnitude compared to its previous bounce (158 points vs 115 points) before breaking its ascending trendline. The index has also rejected a daily resistance area, which is making further progress all the more challenging. There is still room for equities to trade lower without compromising the bullish structure (as long as 2,700.00 can hold), the problem is that it won’t matter for the interest of a re-invigoration in risk dynamics if we continue to see a theme dominated by lower yields and a higher DXY.

EUR/USD:Sellers in full control, all eyes on 1.13 support

Cycles & Levels:The weekly candle printed is an ugly one that appears set to at the bare minimum test the key support at 1.13. Also, it’s the second consecutive rejection off the 50% fib retracement from the 2017 rally. If the price breaks down 1.13, we are looking at a potential target of 1.0863, which will meet the next weekly support. On the daily, I am looking at two targets if a downside resolution occurs. For the developing down-cycle to match its previous one, we require an extension to at least 1.1182 ahead of the 100% fib projection target of 1.1129 as marked by the black rectangle in the chart. The hourly chart, meanwhile, has reverted back to a down-cycle, which makes any intraday rebound into hourly resistance areas potential sell-side opportunities.

Correlations & Volumes:There is all the justification in the world for this market to continue heading lower based on the German vs US yield spread. The recent decline in the pricing of the pair also comes amid a lower German vs Italian yield spread, which is always going to represent an extra weight to the Euro. Last Friday’s tick volume was a touch milder but since it wasn’t interacting with a key daily level, the significance is far from being that relevant.The latest POC can be found at 1.1343, above the price close, which further reinforces the view of sellers being in control short-term.

GBP/USD:In trouble on Brexit, supply imbalances back

Cycles & Levels:The weekly bearish reversal candle is a setback that places the focus back down again. The recent sell-off in the Sterling occurs in line with a developing down-cycle. On the hourly, Monday’s weak opening validates the creation of a new down-cycle, which now ups the odds for any recovery to find growing selling interest towards the immediate resistance areas at 1.2955, 1.2990/1.30 and 1.3038 (all set to provide significant liquidity).

Correlations & Volumes:The correlation values are heading south, hence supporting further falls in the price. The volume has been reduced on the way down, but we are far from a decision level on the daily, which makes the reading of volumes less significant. The highest accumulation of volume (POC) occurred circa 1.3020, which adds to the levels of intraday resistances highlighted above.

USD/JPY: Risk deteriorates but 114.50 still endorsed

Cycles & Levels:On the weekly, we’ve come to a huge level of resistance that encompasses a wide area from 114.00 up to 115.00. The buy-side dynamics heading into this level makes the outlook to be constructive for now. On the daily, the current buy-side campaign continues to develop in line with an up-cycle which has its next target at 114.37 ahead of 114.52 daily resistance. On the hourly, the buy-side dynamics are indisputable, with a series of hourly support levels where liquidity to reinstate longs will be found. Special mention deserves prices sub 113.50, as a static support sees the confluence with an ascending trendline. The order flow on the hourly continues to be supportive of higher levels too, as depicted by the motion of price dynamics (steeper on the way up).

Correlations & Volumes:One of the hurdles faced by buyers is the deterioration of the risk environment, also reflected by a lower US vs JP yield spread. The context to see higher prices is far from being negated though, as even if sell-side interest continues to re-emerge, it looks more logical for the next liquidity at 114.50+ to first be reached in line with the over-ruling component of price structures, which continues to be unambiguously bullish.

AUD/USD: Daily up-cycle, hourly less constructive

Cycles & Levels:From a weekly perspective, the net gains in the Aussie speak volumes of the renewed interest to diversify into the currency. The breakout of the 2018 descending trendline is also a huge milestone. On the daily, the projected 0.73 target acted as the termination point of the recent up-cycle in play. The next target to the downside looks set to be 0.7156 (retest of broken resistance). On the hourly, the violation of the ascending trendline along with a double top has turned the prospect very short-term to the downside. There are a significant number of supports and resistances that populate the hourly chart, where buyers and sellers will find the next decision points.

Correlations & Volumes: As the valuations of related markets stand, it does not justify a higher Aussie. The collapse in Gold, the strength in the DXY or the weakness in the Yuan are all impending factors set to weight on the Aussie. Even if we are seeing higher Aus vs US yield spreads, the rest of factors make up for the positives here. Last Friday’s POC can be found trapped to the upside at 0.7243, which makes the downside to be the vulnerable side for now.

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