The Daily Edge

GBP Hit By Risk Of Snap Election

The article is authored by Ivan Delgado, Market Insights Commentator at Global Prime. This content aims to provide an insightful look into topics of interest for traders. Feel free to follow Ivan on Twitter & Youtube. Make sure you join our discord room if you’d like to interact with Ivan and other like-minded traders. Also, find out why Global Prime is the highest-rated broker at Forex Peace Army.

Quick Take

It was a quiet Monday for most of the currencies as the US and Canadian markets were closed due to Labor day, essentially clearing the landscape to make the GBP the absolute focal point as volatility, once again to the downside, hit the currency as the risk of a snap election in the UK is on the rise. GBP traders must be aware that trading the currency in the coming weeks and months is going to be a minefield of headline-charged price fluctuations, which increases the risks considerably. Meanwhile, the close of markets in the Weste hemisphere didn’t make any difference to alter the steady uptrend in the USD, with the JPY and the CAD following from distance. The markets that appear most at vulnerable to further downside pressure remain the AUD, NZD, EUR, and to a lesser extent the CHF, which trades at fairly cheap levels based on the risk profile.

The indices show the performance of a particular currency vs G8 FX. An educational article about how to build your own currency meter 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.

Risk of a general election in the UK: There is a growing risk that the UK is headed towards a snap election, which has led to the Pound losing further value against its main rivals. Sky News/ITV broke out the news by noting that if the UK Parliament passes a bill to kick the can down the road by forcing the UK PM to extend the Brexit deadline today (Article 50) by October 19, in that case, then PM Johnson will carry out a motion for a General Election to be held on October 14. If the emergency motion does not get enough support, UK’s Labour Corbyn said: “then all there’s left is to call a no-confidence motion before the end of the week.”

Bill to block no-deal Brexit takes center stage: The rebel/opposition bill goes for a vote in the UK this Tuesday, aimed to gather enough MP support to legitimate the Parliament to demand a 3 month Brexit extension to 31 January 2020 from the October 31 deadline subject to MPs having not yet approved a deal or if Parliament has agreed to no-deal by October 19. PM Johnson has retaliated by saying that “there are no circumstances under which I will ask Brussels to delay” while worried that these tactics debilitate the UK’s leverage to negotiate with the EU.

China-US struggle to schedule trade talks: A number of reports are doing the rounds about the difficulties faced by China and the US to agree on a September meeting for trade talks. The 70th anniversary of the founding of the People’s Republic of China on October 1 and the Party’s Fourth Plenum due afterward, makes scheduling meetings quite a challenge.

China’s Caixin/Markit PMI surprises to the upside: The indicator came upbeat at 50.4 vs 49.8 exp, which creates a conflict with the official PMI published over the weekend at 49.5 vs 49.6 exp. As the statement by Caixin/Markit notes: “China’s manufacturing sector showed a recovery in August, mainly due to improved production activity. However, overall demand didn’t improve, and foreign demand declined notably, leading product inventories to grow. There was no sign of an improvement in companies’ willingness to replenish inventories of inputs or in their confidence. Industrial prices trended down. China’s economy showed signs of a short-term recovery, but downward pressure remains a long-term problem. Amid unstable Sino-American relations, China needs to step up countercyclical policies.”

The RBA in focus: The policy meeting will command the market’s attention, with the reaction in the Aussie a function of how dovish they sound. The chances of a rate cut in the September meeting, amid improvements in the labor data are slim. RBA forecasts still assume 2 further cuts, which might come later this year and then in Q1 or Q2 2020. The risk, all else equal, is skewed towards the RBA pulling the trigger earlier as the global slowdown and the lingering Chinese trade war with the US takes its toll globally. Besides, if there is additional evidence of poor Q2 GDP or retail sales this week, which would follow the disappointing Q2 construction and building approvals data, it may trigger an October cut. A key signal to monitor in today’s Goveor’s Statement will be whether there is a reiteration of the wording “ease monetary policy further if needed”.

The US ISM manufacturing up next: The PMI is due at 10.00am local time, with consensus looking for an unchanged reading of 51.2, which would be below the long-run average of 52.9. The recent escalation in tariffs may have a negative influence in this month’s survey as the majority of responses tend to be submitted late in the month.

Recent Economic Indicators & Events Ahead

Source: Forexfactory

A Dive Into The Charts

The indices show the performance of a particular currency vs G8 FX. An educational article about how to build your own currency meter can be found in the Global Prime’s Research section.

The EUR index exhibits bearish dynamics, well below its baseline in a move that still appears to be rather overextended, with little to no rebounds ever since the breakout of its range. Unless playing momentum strategies or scalping for small profits here and there, the index does not offer attractive levels to be jumping on the bearish bandwagon just yet. Also notice, the aggregate tick volume has been running below the average and forming a taper formation, which is not a great signal if one is expecting the trend to continue its course unabated.

The GBP index shows a bearish outlook as the price retus below the daily baseline (13ema), even if the lack of aggregate tick volume warrants caution. The GBP will be subject to the barrage of political headlines coming out of Westminster this Tuesday, as the opposition parties and rebel MPs look to make the very last ditch effort to pass a bill in order to stop a no-deal Brexit from happening. It’s a very risky business to get involved in trading the GBP unless you are a scalper or a momentum trader in the lower time frames. Not for the faint-hearted.

The USD index keeps making further leeway, with the separation between the current price and the daily baseline (13ema) increasing the risk to join the uptrend blindly. It’s best to exercise patience until there is a pullback that can offer a better pricing if you are looking to ride the trend for anything longer than a few hours. For the shorter timeframe traders, the momentum is definitely very strong, which supports the notion of looking to engage in longs at any potential opportunity that your trading system may provide. Remember, the shrinkage of USD liquidity (supply side) this quarter appears to be a key factor keeping the currency in high demand. 

As a reference, this is what I wrote in yesterday’s note: “The US Treasury will remove liquidity from the commercial banking system this quarter by borrowing around $430 billion, which implies a form of quantitative tightening. The more scarcity of USD, the worse it is for risk conditions. Also, the cost of short-term borrowing goes up, also known as repo rate. Besides, if foreign financial institutions fail to meet the minimum regulatory requirements to hold USD-denominated assets, it can lead to banks forced to deleverage to obtain the extra USD. What’s more, the reverse repo program between the Federal Reserve and foreign central banks has grown to over $300 billion, reducing the supply of USD further.”

The CAD index appreciation keeps ongoing, which is a scenario that had the technical backing after the price broke out of its August range late last week. The follow-through demand in the CAD follows a retest of the prior resistance-tued-support as the index now threatens a retest of its most recent trend high, allowing significant room (~0.4%) to appreciate. Note, I find it unlikely that the CAD can continue breaking higher above the recent peak based on the massive divergence that exist with the risk-on weighted index (orange line), which suggests the higher it goes, the more value exists to short the currency at wholesale levels.

The AUD index is no man’s land within the context of a range found, which is part of a broader bearish trend that has been well established since the aggressive July sell-off. Today’s directional bias in the AUD will be dependable on the outcome of the RBA. On the topside, there is a critical level of resistance nearby, while the room to fall appears more ample until support is found. Remember, the risk-on weighted index remains very depressed, which is a clear foreboding signal that any spike in price towards key levels may see sellers gratefully stepping up.

The NZD index outlook remains very bearish with no evidence that the tide is tuing anytime soon for the interest of buyers. Even Monday’s recovery in price carries very little conviction judging by the poor participation in buy-side pressure (via aggregate tick volume). The risk-on line (orange) is also very depressed, which is not helping the outlook for the Kiwi. Overall, there is no reason to abandon the bearish bias in this market. Steady as she goes.

The JPY index remains at risk of higher levels as it trades comfortably above the baseline with the risk-off weighted index (orange line) at very elevated levels. Just as in the case of the NZD there are no technical grounds to be bullish, the opposite applies to the JPY, there is absolutely no reason not to think that the JPY is not going to continue trending higher from here.

The CHF index is one of the markets where the discrepancy between the risk-off weighted index and the current pricing of the index has to sooner or later close. What this means is that the risk of the CHF attracting buying flows remains considerable, even if technically there are still no clues, as the index heads into its 4th day of trading below the daily baseline, not seen since early April this year. Just as the CAD is trading dangerously high when crosscheck against risk, the opposite view can be applied when looking at the CHF, looks rather cheap.

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