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The Focus Turns to the ECB, Glass Half Full or Half Empty?

The Focus Turns to the ECB, Glass Half Full or Half Empty?

Don’t we feel all as having a Brexit overdose? For once, and without setting precedence, I am especially enthusiastic to hear what Mr. Draghi has to say.

The Daily Digest 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 for the next 24h of trading in order to assist one’s decisions on a regular basis. Follow Ivan on Twitter.

Summary — Dec 12, 2018

Don’t we feel all as having a Brexit overdose? For once, and without setting precedence, I am especially enthusiastic to hear what Mr. Draghi has to say. Will his speech leaves us a sense that the underlying weakness in the Eurozone through H2 is transitory or will Draghi exhibit a greater degree of concern, implying that the slowdown in the Eurozone is more durable?

Another focal point for today’s meeting includes the discussions about QE reinvestments, with expectations for more clarity as bond maturities come due. The forward guidance on the reinvestment period, the average maturity and the composition of the portfolio are the key aspects to keep an eye.

The perky Pound found plenty of buying interest, which feels counter-intuitive, although judging by the overextension of the sell-off, that was a risk to face. The fact that UK PM May survived the leadership challenge by a decent margin (201 vs 117) feels like still not enough.

Viraj Patel, FX & Global Macro Strategist at ING notes, that “the opposition may think 117 is big enough to topple the government in Commons & see a general election”, thus “the risks is that GBP continues to drift lower especially if UK opposition parties now push for a Commons no confidence.”

Also, as part of today’s bonus insights, I update readers with yesterday’s trade idea, when I endorsed playing a long position on CAD/JPY based on the risk profile recovery I was expecting. Filled in Asia.

As per today’s tweet shout out, it goes to arguably one of the top macro traders helping me to stay updated day in and day out on the latest developments in the market. @fxmacro is a must-follow.

Market Drivers

  • UK PM Theresa May won the conservative leadership challenge by a decent margin of 200–117. Despite the victory, anyway you slice it, the bottom line is that UK May’s is caught between a rock and a hard place amid disagreements between her deal and what the UK parliament demands to make a soft Brexit a viable outcome.
  • The events in France since the violent protests over the weekend are significant. Firstly, it has led France’s President Macron to backtrack its mandate with the EU by implementing emergency measures which will cause the country’s budget to blow up above the debt to GDP ratio of 3%. You can’t then argue for Italy to stick to the disciplinary rules if France is the first one to bend them over. The prospects of European integration have been damaged.
  • A new short-term driver for the Euro the market is watching very closely is the spread between the French and the German bond yields. Some could argue that until the dust in France settles, it poses significant risks for the outlook of the Euro, as France is the new Italy.
  • Italian PM Conte has assured EU counterparts that the revision of the country’s budget will comply with a target matching up to the expectations for a 2% debt to GDP for 2019. Judging by the levels of the Italian yields, the market continues to give the benefit of the doubt.
  • The Sino-US relationship appears to have been unaffected by the Huawei CFO arrest saga. More evidence emerged over China keeping its word on Wednesday. According to reports, Chinese state-run firms have bought over 500k tonnes worth $180m. The thaw goes on.
  • The narrative coming out of China does seem to carry substance, as according to the WSJ, China mulls to make changes to its Made in China 2025 plan that would facilitate greater access to foreign companies within its borders. For now it’s all promises but the tone i and the current thaw achieved is a source that on its own should continue to back-up risk.

Fundamentals

  • Not much to chew on during Wednesday, with the US CPI numbers, headline, and core, coming in line with expectations at 0% and 0.2% m/m respectively, while Canada’s capacity utilization fell to 82.6% from 84.1%.

Events Ahead

  • The focus is on the ECB meeting this Thursday, with calls for the ECB to possibly downgrade growth and inflation through 2019. Find below a preview of the event put together by the Economics Team at Barclays.

Risk Model

The risk-weighted index found a fresh leg up, breaking the previous high, assisted by the rise in both the S&P 500 and US rates, while the US Dollar trades on the backfoot. The current profile, based on the latest movements in financial markets, is characterized by classic ‘risk-on’ conditions.

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If we were to take cues from cross asset classes, the outlook for risk heading into Thursday continues to be vindicated by the new structure high in the RWI, the uptick in junk bonds, even if prudence and be on high vigilance is still warranted as the VIX remains very elevated at 21.5.

By taking a look at the yield curves, the true ‘risk on’ profile is supported by the steepening of the US yield curve (10y-2y), which communicates a diminutive improved outlook for growth. An analogous move has eventuated in the Japanese yield curve, giving us a promising jump start in Asia.

Also, the moment the ECB is out with its latest policy statement, expect risk-sensitive assets to re-calibrate their valuations based, in part, to the ripple effects of the stance by the ECB.

As a reminder, the latest changes in options positioning have played a key role in defining my view over the potential recovery in risk. My constructive outlook was aided by the increasingly aggressive buy-ups of IM calls in both the S&P 500 and the US 30-yr bond yields, as documented yesterday.

Forex Majors

EUR/USD — Barring An ECB Shocker, Buying Weakness Favored

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In terms of valuations, Wed’s bullish price action came amid an alienation of a bet returning towards the 5-yr German vs US yield spread, with another positive emanating off the 10-yr German vs Italian yield spread, making a fresh cycle high. Even the 10-yr German vs French yield saw a bid coming back, allowing to remove some pressure off the European-shared currency.

On the daily, my endorsement to play longs on weakness remains unabated. Notice the range is getting narrower, with the closes by 5pm NY time in the last 2 weeks waxing and waning between 1.13 and 1.14. What this means is that a period of compression tends to follow one of expansion.

We need to always ask ourselves the right question. If we were to bet for a breakout in either direction, judging by the clues obtained via options and yield spreads, which direction is more likely? The answer to me, as a close observant of intermarket relationships and options activity. I want to be a buyer of Euros at these markdown prices owed to the major disparity in German vs US yield spreads, but also on the clues I am getting via where option players are buying up downside protection, with out of the money puts finding a higher level of accumulation in the 1.13–1350 vicinity.

On the hourly chart, I’ve marked the key levels of liquidity as usual. Note, some initial technical cracks are taking place after the clear violation of the descending trendline off the Dec 10 high. Wednesday’s recovery in the Euro found a cluster of offer circa the most recent POC around 1.1380 as depicted by a rectangle in my hourly chart. For the next 24h, subject to a shocker by ECB’s Draghi, I will concentrate my efforts in engaging in buy-side action off liquidity levels. Any levels sub 1.13 would present, in my opinion, a stellar opportunity to load Euro longs.

GBP/USD — Boosted After UK May Survives Confidence Vote

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The Sterling valuation continues to favor the upside based on the UK vs US 5-yr yield spread, while also assisted by the recent downtick in the USD. However, in the wider context, there are still more ‘cons’ than ‘pros’ to be a buyer in this market. The political disarray in the UK remains a major source of concern for markets, and while UK PM May has won the confidence vote, fears are growing that she is really trapped in a ‘cul the sac’ Brexit road with no easy way out. Not enough votes in the UK parliament to get her Brexit deal through and no willingness by the EU to make the substantial tweaks to the compromise, so that the Irish backstop sticking point is resolved. I feel that part of the recovery in the Pound on Wed was partly due to an excess of bad news priced out, although on the grand scheme of things, the breakout of support at 1.2680–27, has set in motion targets as low as 1.2140.

On the daily chart, we can clearly see the Sterling edging close into its previous support turned resistance at 1.2660 up to 1.27, which should cap the gains for now. On the hourly, the buy-side interest has been very significant, to the extent that a new bullish cycle has now been validated. What this means is that those with an interest to buy the Sterling on dips have now a more constructive technical backdrop to lean on, although still in disagreement with higher time frames.

USD/JPY — No Change In Outlook, Short-Term Bullish

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Nothing has changed in terms of valuations for this market, which are unambiguously bearish & predicated on the depressed levels of risk and the US vs JP yield spread. However, short-term, it is the bulls that have taken clear control after the massive bullish outside day on Monday. I am still betting of a market that lacks any sort of conviction to break out of its 112.30 -114.00 range. The FOMC meeting next week could change all that depending on its narrative.

On the hourly chart, the bullish run has so far produced 2 legs up, which makes me think that we might still be missing a third push higher to retest the 113.50 high ahead of the next topside targets at 113.75 and 114.00, which is where I’d expect the pair to start trading topish with true value to engage in sell-side campaign if traders can align the macro value gap with the micro ones. As long as buyers can keep the price above the 112.90, the structure of the market favors the long-side.

AUD/USD — In Familiar Range, Topside Test Eyed

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With the offshore yuan regaining its strength and the Hang Seng index supported by the recovery in risk appetite, the outlook for the Aussie appears to have improved. What this means is that the topside of its 1-week range at 0.7235–40 may continue to be tested, with the price action still building higher highs and higher lows intraday. I’ve drawn a rectangle across the midpoint of the range, which often tends to help us as a precursor to understand what side of the range may breakout first. This theory is predicated on the basis that if a particular side takes control of the midpoint of the range through various rejections, it will communicate an interest to test the top/bottom side next. Bottom line, the Aussie is trapped in a range, with risks building up for a possible upside breakout.

Bonus Insights- What Are You Missing?

An update on yesterday’s CADJPY long idea: I was filled long o/n, in lien with a risk reprieve expected, stark contrast in recent fundamentals (JP GDP 👎, CA jobs 👍), Oil anchored by $50.00, plus steeping of US & JP yield curves offering positive lead for risk in Asia too. Find the insights below.

Today’s Twitter Shoutout

If you want to be satiated with all the latest macro news, especially as they relate to forex, here is a must follow contact for you. He goes by the handle @fxmacro and he is someone who just happens to be constantly in the flow of the moment, keeping us all up to date with the latest developments.

Quote of the Day

“A lot of people get so enmeshed in the markets that they lose their perspective. Working longer does not necessarily equate with working smarter. In fact, sometimes is the other way around.”

Martin Schwartz.

Like What You See?

Soon you will be able to subscribe to receive ‘the daily edge’. In the meantime, feel free to follow Ivan on Twitter.

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.
  • 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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