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.
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Quick take (express version)
If you’d rather just to stick with the key points, this is for you. The market is starting to believe that a pause in the Fed’s rate hike is a plausible scenario judging by the performance in US yields/DXY. Meanwhile, risk conditions are deteriorating further, led by a sharp bearish reversal in the S&P 500 as US credit and housing are two major conces heading into 2019 (more details below). We didn’t see any newsworthy influencing the price of currencies emanating from Brexit or China trade on Monday.
The outlook for currency majors continues to be USD bearish, even if I am spotting some short-term intraday reversal opportunities based on the 100% proj targets met in EUR/USD and USD/JPY. The Sterling is encapsulated in a tight range awaiting new headline triggers out of the Brexit situation. The Aussie might be on the cusp of another push higher judging by where it trades (buy dips market). In today’s report, I also note a potential short-side business proposition in EUR/JPY based on sentiment and valuation. Earlier on Monday, I also noted a compelling long that may be building up in the AUD/NZD market after reaching a projected target.
The sell-off in the DXY comes in line with a much more prudent stance by futures and options trades as per the last CoT report.
Fundamentals: Break down of market drivers + key releases
Not a whole lot of new developments in the fundamental space. The first thing that shocked me this moing was the poor US housing data release as worries are mounting. The huge drop in the US Nov NAHB housing market index, which came at 60 vs 67, marking the lowest since Aug 2015, is certainly a reason for conces. The narrative towards slower growth has been picking up, hence this shocker release is not going to alleviate the uncertain outlook.
It’s precisely on this point above that I’d like to elaborate further. A Fed pause or even a sudden peak in rate hikes should not be ruled out as financial conditions in the US tighten. The volatility in the US equities, the worsening outlook for US credit, the more cautious shift in rhetoric by Fed’s policymakers, the collapse in Oil price damaging the outlook for inflation, the late business cycle we are at, the twin deficit (budget and trade), the fading fiscal stimulus.
There are many arguments to be made for a potential pause in 2019. Moreover, the fact that a press conference will be given at every meeting from now on is an opportunity for the Fed, if they wanted to press the brakes, to properly articulate the motives.
In the UK, many uncertainties are still surrounding Brexit, but nothing noteworthy in the last 24h as depicted by the compressed range in the Sterling. Spain is reportedly dissatisfied with May’s withdrawal agreement, which only adds to the jitters should May find herself in further political pressure if faced with a ‘no-confidence’ vote. Until now though, she is trying her best to get the job done, even to the extent that she has taken on the role as UK Brexit Secretary too as she battles through muddy waters to honor the people’s choice to leave the EU with the best possible terms.
In the trade war between China and the US, some of the positive narratives were somehow unwound over the weekend, after leaders of the Asia-Pacific Economic Cooperation (APEC) group failed to agree on a communique for the first time in APEC history due to the ongoing differences between the U.S. and China on trade.
Until the G20 summit later this month, the benefit of the doubt is definitely still playing out or else we wouldn’t be seeing the strong recovery in the Aussie or in emerging markets for this matter. I still find it very hard to see a potential agreement on trade as the dispute is more a hegemonic one, with the ‘made in China 2025’ grand vision at the epicenter as a major sticking point as it’s in direct collision with Washington’s Indo-Pacific Strategy.
Risk model: Equities continue to rule risk as USD selling extends
Our risk-weighted index has deteriorated sharply towards a retest of the previous day lows. The downward pressure came as a function of the sell-off in both equities and US yields. We knew the environment was dominated by USD weakness, hence why the performance of US equities was critical to gauge risk.
The order flow in the last 24h has maintained the familiar theme of broad-based USD weakness, with the not so subtle difference that the correction in the S&P 500 appears to now be over. The depressed levels in the high yield corporate bonds (HYG ETF* ) last Friday in divergence with the behavior of equities was a red flag.
*HYG is one of the most widely used high yield bond ETFs.. Providing exposure to a broad range of U.S. high yield corporate bonds. The lower the index goes, the worst the outlook for what’s often referred to as junk bond or high bond corporates.
The reality we are faced with is that we are finally seeing the flows in equities re-calibrating with the underlying cycle low as depicted by the black lines in the chart above. There is no reason to believe the bearish momentum in the S&P 500 won’t stay its course after the mentioned re-alignment of flows + cycle, hence why a recovery of risk courtesy of higher stocks looks like a distant prospect.
If the above premise holds true, and the S&P 500 cannot act as a factor to lift sentiment, we should then see a combination of higher US yields and a continuous weakness in the DXY. On the former, the daily support at 3.31% still offers some respite, although for now multiple topside attempts have been rejected around 3.36-37% on the long-dated 30-year. With respect to the DXY, the index has reached its 100% proj, so I am expecting short-term strength as a potential outcome, although I must say that the outlook is somewhat eclipsed by the bullish breakout seen in the EUR/USD through a key descending trendline. Irrespective of the short-term flows, which might occur, a downcycle structure rules now.
Overall, the outlook for risk sentiment to recover from its current undermined position is a challenging one. While short-term flows may see some relief-rally intraday, that should play into the hands of risk sellers judging by the structure of the market.
EUR/USD: Structural cracks, next target at 1.1490/1.15
In the EUR/USD constellation, the stars are aligning for what may represent a major macro shift in structure. Earlier on Monday, I tweeted the following: “$EURUSD 3 pushes down on the daily, each one weaker in magnitude. Watch a potential break of the confluent area at 1.1435/50. If acceptance above, this may represent a significant macro shift in structure judging by the maturity of the down-cycle. Latest $COT strengthens case”
By the close of business on Monday (5 pm NY), the breakout and acceptance above the trendline has materialized now, which indicates the first real cracks of the bearish structure that began in late Sept. The build-up of gains occurs with the backing of a bullish outside day at the 50% fib retrace of the 2017 run-up.
On the very short-term, the impulsive run-up has now met a market-makers’ sensitive area at 1.1454 where profit taking is expected, as it represents the 100% projection target from the previous hourly range. Some intraday opportunities to be a seller might arise. Just be mindful that support will be found circa 1.1420 and 1.14/1395. If the gains extend, 1.1490/1.15 will be absolutely huge resistance.
The ebullient mood in the EUR is also supported by the breakout of structure in the 5-yr German vs US yield spread, as depicted by the blue line in the yield chart above. Interestingly, the rise in the EUR occurs at a time when the German vs Italian 10-year yield spread is trading at year lows, which could create downward pressure near-term. If it doesn’t and the breakout of 1.15 is validated, it will be the ultimate sign that the market is moving away from Italy’s conces.
GBP/USD: Volume down into resistance, UK vs US yield spread at year lows
I will not be spending much time analyzing the Sterling amid the lack of new technical developments. The only aspects of note include the reduction of volume into an area of resistance at 1.2890/1.29 following a rebound off the 100%proj target. The tapering of volume into an area of high interest does not bode well for buyers. Meanwhile, the UK vs US yield spread continues to argue for lower levels. As usual, be on the watch for Brexit headlines.
USD/JPY: Sellers build 2nd cycle down, risk conditions unsupportive
Last Friday’s confirmation of a bearish outside day has set up in motion what should be the continuation of an offered market. The daily cycle remains up but the last leg failed to neither reach the 100% proj target nor retest the previous high. That has set out a counter-cyclical move with potential credence to compromise the constructive outlook.
As consolation for Yen bears, the latest CoT report indicates a market still overly committed to play USD/JPY longs, but with risk-off conditions firmly in place and what might be a transition into a structurally bullish EUR/USD, it certainly represents a tough backdrop to expect topside overextensions.
The dubious upside potential in USD/JPY is somewhat re-asserted by the large magnitude and impulsiveness of the 2nd cycle down on the hourly. It sets up the stage for a 3rd pushdown, although not before a potential correction from 112.50’s 100% proj target.
AUD/USD: Buy-side campaigns far from over as cycles stand
Be reminded that the weekly close last Friday confirmed a bullish outside continuation candle. Even more critical, price found acceptance above the 0.73/7315, allowing further leeway until the next bullish target at 0.7364 daily resistance. The higher auctions we are seeing has also validated a new up-cycle (2nd).
So, with the higher timeframes firmly bullish, the market should continue inclined to find value in engaging in buy-side business on weakness. As I type, the pair has retraced down towards the third test of its ascending trendline on the hourly, from where a new buys9ie campaign into the recent highs may be seen.
Looking at the correlations, the move higher in the Aussie continues to be guided by the up-cycle in the AU vs US yield spread as well as capitalizing on the weakness present in the DXY.
Bonus charts: What are you missing?
Heads up for value traders as EUR/JPY is still being dealt at discounted prices if we account for both risk sentiment and yield spread (on down-cycles) while the pair still finds further bids into a key resistance area. It’s also worth noting the divergence in its correlation 30-period + volume decreasing. The higher the pair goes, the more attractive the selling proposition may become.
A compelling long that I tweeted yesterday includes the AUD/NZD. We’ve seen 2 intervals of normal distribution reached 100% proj target / Area of daily support, both time rejection w/ speed + break of structure (high-quality area of interest) / AU vs NZ 5-yr yield spread on a recovery as well / Risk reward of 2.5 to 1 is available.
Bitcoin is making headlines once again, although unlike late last year, this time is for the wrong reasons as the value keeps plummeting. There are many calls being put out, so I thought I’d run a logical normal distribution target based on 2 different intervals. The first immediate target can be found around $4,165.00, that’s where we should see the first significant tuaround in prices. The second midterm target expands all the way down to around $3,000.00. I’ve seen many calls for precisely this number as the next major downside target, and I must say that based on the principles of market efficiency and normal distributions, it does look logical.
Intelligence gathering: Insights from bank research reports
Morgan Stanley remains supportive of further USD weakness on the basis that the Fed has recently re-calibrated its narrative towards a more prudent stance on growth as I reported above. According to the bank, there is more catch up to do by the DXY to re-align with the sharp falls in the Eurodollar 2019-2020 spread. Morgan Stanley also touches on the deterioration of US credit and tightening conditions as another source of conce. A point that I’ve recently harped on, that is, the US is set to lose growth momentum into 2019 as the fiscal boost fades is a key theme the bank also endorses.
I also want to bring to the readers’ attention a relevant snippet of information via Credit Suisse, where renewed interest to be a EUR buyer by real-money accounts has been noted. An over-owned USD may see further upside in the EUR/USD they rationalize.
Barclays continues to hold a rather pessimistic stance on the outlook for growth out of China, concluding that a reduction in the 2019 GDP outlook is justified. According to the bank, the risks are emanating from escalating tariff dispute, moderate monetary and fiscal policy efficacy, and the possibility of Sino-US tensions extending to issues beyond trade.
- Risk sentiment 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 HowTo Read Market Structures In Forex
- POC: It refers to the point of control. It is depicted by a red line on the bottom right side chart for each candle. 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 Howto 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 onWhy Is Tick Volume Important To Monitor?
- Horizontal Support/Resistance: Unlike levels of dynamic support or resistance 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 that can add an edge to your trading. 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 tutorialHowDivergence In Correlated Assets Can Help You Add An Edge.
- Fundamentals: It’s important to highlight that this outlook 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 the100% Fibonacci projection resides in the symmetry and harmonic relationships of market cycles. By drawing a 100% Fibonacci 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 onThe Magical 100% Fibonacci Projection
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