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Relentless USD Demand, Mysterious Equity SellOff

Relentless USD Demand, Mysterious Equity SellOff

Traders were left scratching the heads after a late sell-off in the S&P 500 led to a 'true risk-off' tone on Monday. The breakout of the range in the EUR/USD, the broad-based temporary demand for the Japanese Yen were some of the highlights in the currency market.

Date: 3/5/19

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.

Quick Take

Traders were left scratching the heads after a late sell-off in the S&P 500 led to a 'true risk-off' tone on Monday. The breakout of the range in the EUR/USD, the broad-based temporary demand for the Japanese Yen were some of the highlights in the currency market. The market is paying an awful lot more attention to yields as of late, as the correlation coefficient measurements in the Intermarket analysis section below shows. I also draw some parallels about the selling in stocks and the potential period we may be entering, in which the market reaches a period of climax optimism, having fully priced in the Sino-US trade deal, which according to a report by the WSJ over the weekend, looms near. As I remind the audience, it is precisely this 'buy the rumor sell the fact' dynamic what followed the first halt of tariff increases last year. Dejavu?

Currency Strength Meter

With the late NY ‘risk off’ twist came even more ample demand towards the Yen, which ended Monday as the best-performing currency. The currencies that followed by putting on a decent performance included the US Dollar as a ‘risk off’ currency, and surprisingly the Kiwi and to a lesser extent the Australian Dollar on hopes of an immediate Sino-US trade deal and one would think lack of interest to commit in either direction ahead of today's RBA policy meeting. The Sterling, the Euro and a battered Canadian Dollar did poorly, the latter still dragging on its downward momentum since the big miss from Friday’s Canadian GDP numbers.

In the 2nd window below, we find 3 currencies (GBP, USD, EUR) still displaying a macro trend as per the slope of the 5-DMA (125-HMA), while commodity currencies (AUD, NZD, CAD) and the JPY are yet to find sufficient demand interest to shift the dynamics of its weekly trend (macro measurement). The latter is rapidly getting there and much of its outlook going forward will hinge on the performance of equities.

Narratives in Financial Markets

  • A rather mysterious late sell-off in US stocks erases all the gains and some more from the main US equity indices, including the S&P 500. Talk in the floors has it that such reaction without a particular catalyst at a time when the WSJ had reported that the US and China were almost done hashing out all the necessary details before US and China Presidents sign it off.
  • Market participants should be reminded that a ‘buy the rumor sell the fact’ dynamics in the Sino-US trade conundrum was precisely what preceded the decision from the Trump administration back in Q4 2018 when the US halted further tariff increases on China as a transitionary period of negotiations followed, which is still dragging on. The day of the announcement led to a significant top in risky assets across financial markets.
  • US December construction spending fell by 0.6% vs +0.2% expected. The data will undoubtedly weight on the next reading of the US GDP and understandably adds concerns to a slowdown in the US economy on the back of last Friday’s disappointing US ISM and consumer confidence.
  • According to Reuters, citing sources familiar with the matter, June OPEC meeting is likely to extend curbs through year end and may only discuss easing supply caps if the output drops further in exempt producers, with Iran being the main actor involved if US ramps up sanctions.
  • Canada has agreed to extradite China’s Huawei CFO to the United States. In a separate report, the NYT reports that Huawei is looking to sue the US government for banning federal agencies from making use of its products. The detention of the Huawei executive has caused increased tensions among the US and China but not to the point of derailing trade negotiations.

Recent Economic Indicators & Events Ahead

Source: Forexfactory

RORO - Risk On Risk Off Conditions

Micro conditions: The spontaneous setback in US equities late on the day has led to a turnaround lower in the 25-HMA, which when combined with the bearish move in US yields and the sustained demand in the DXY puts us in a short-term (micro) risk-off environment. What this means, as the table above explains, is that “the market is in fear mode, deleveraging off riskier bets. Traders will be looking to buy jpy, usd, keeping an offered tone in commodity currencies unless fundamentally driven events still promote demand flows. The eur and gbp tend to stay under pressure, but not as much as commodity-linked currencies. Any positive fundamentals on risk currencies likely to be faded as risk off dominate.”

Macro conditions: Even the macro picture has turned ugly, as the 125-HMA downward exhibits and finally carves out a bottom in the DXY. These two assets moving in such respective directions, independently of the moves of the US yields, makes for some poor dynamics to support risky currencies. If the long-dated US yields were to also confirm a macro bearish trend (for now only micro), we’d be entering a ‘true risk off’ scenario. Until then, the conditions are best classified as macro USD strength (risk cues from equities). As per the table above, “when the usd and US30 yr bond yield move higher, look for clues via the S&P 500 and potentially gold to determine risk. If the S&P 500 is higher, the risk may still be conducive unless gold rises too (rare as usd strength caps price). Under this context, the usd strength, indirectly, adds pressure to EMs and may keep aussie or kiwi under pressure vs eur, gbp, cad.”

Dashboard: Intermarket Flows & Technical Analysis


EUR/USD: Breakout Of The Range Shifts Focus South

  • Correlation with the 10y yield spread remains strong, which reinforces sell on rallies.
  • The resolution of the range sees a move strong in magnitude and speed, it creates a new bearish structure and it suggests supply imbalances may persist based on dow theory.
  • Both the micro and macro trends as per the 25/125HMA slope in line for a bearish continuation, which is further evidence on top of the downward structure based on cycles.
  • The 10y yield spread ends NY on an upward micro slope, which sees potential capital flows returning for a retest of the 1.1360 vicinity for a backtest of the range breakout.
  • Sellers should keep control of the 1.1385 level (midpoint of the broken range) to stay in charge of the directional bias, which for now has set out to be in their favor.

GBP/USD: Cluster of Bids Kept Selling Contained

  • Overall USD strength keeps the Sterling lower, which is also a function of the current pair’s regime, a clear proxy of the DXY (runs high correlation coefficients).
  • From a micro standpoint, there are no indications of buyers ready yet to step in unless algo-led spontaneous spikes on Brexit headlines or a significant setback in the USD, which is not foreseen now that the micro and macro trends in the DXY are both pointing up.
  • From a macro perspective, the only arguments to be found to keep the prospects of a trend resumption alive include the bullish macro slope in the UK-US bond yield spread, the macro trend based on the price of the pair (125HMA slope upwards) and/or positive Brexit headlines.

USD/JPY: Risk-Off Hiccups Result In Range Establishment

  • The disjointed currency market has seen solid USD demand both at times of ‘risk on’ but also ‘risk off’. The sell-off in risk on Monday has led to ample demand for JPY as one would expect, resulting in a range between 111.60 and 112.00 within the context of a bullish trend.
  • The all-time favorite correlation of following the DXY and US yields to determine the USD/JPY direction is back in vogue, running very high correlation coefficients (exc 1-month DXY).
  • If the short-term risk-off conditions we ended NY with persist, any retest of 112.00 (range top) should translate in value propositions to be a seller on strength even if one must be are that the trades would be against the dominant bull trend.
  • Buy on weakness becomes a Go-To strategy as long as the slopes of the DXY and US30Y both point in the same direction. Micro-wise the US30Y hinders the bullish prospects. From a macro standpoint, if equities find renewed demand, the macro DXY/US30Y still promote buy on dips.

USD/CAD: Firm Uptrend, Equilibrium Found At Hefty Levels

  • The sustained buying despite 24h+ of overbought conditions on the hourly as per the slow stoch is a reflection of the ample supply imbalances on the CAD post-Friday’s GDP miss.
  • We are starting to see the market paying more importance to the US-CA bond yield spread, as the focus shifts back towards a more dovish BOC this week after the dismal CA GDP read.
  • Other than the recovery in Oil prices, which has been ignored by negative CAD flows, the rest of technical/intermarket measures point at further strength in this market.
  • The risk-reward prospect is never going to be too attractive for a swing/day trader after 24h+ of trading under overbought conditions. Momentum traders still thriving in this market.

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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