The Daily Edge

Risk & DXY Solidify Post US, China PMIs

Date: 4/2/19

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

The Canadian Dollar, still fueled by the impressive Canadian growth figures from last Friday, and backed up by ‘risk on’ and the rise in Oil, keeps finding the most demand. Following at a certain distance is the US Dollar, making solid gains across the board except vs the CAD as noted. A strong US ISM is the reason behind the surge in USD demand, with the upthrust day in US yields, no longer in negative yield curve (10y-3m), underpinning the move. The Japanese Yen was the clear underperformer in a day where the promising US ISM came combined with back-to-back positive Chinese PMI readings (official and Caixin). The S&P 500 broke its previous swing high, and it’s looking increasingly likely that the record high from last year will, at some point in Q2, be retested again, in what would be one of the fastest recoveries from an officialized bear market (after a 20% down last year) in the history of the S&P 500. The V-shape type of bounce is a very rare occurrence. A currency that is trading at the beat of its own drummers is the Sterling, with moves currently 100% dependable on the Brexit saga, as we navigate through the peak noise stages. The Euro remains under pressure on the back of yet more disappointing data out of Germany (PMI) and low inflation readings in the EU. Lastly, the Aussie has been sold immediately after the RBA policy decision.

Key Narratives in Financial Markets

  • US ISM Manufacturing PMI came upbeat at 55.3 vs 54.2 prior, throwing cold water to doomsayers that a recession in the US may be nearing after the buzz around the inversion of the US yield curve, which has reversed to positive on the widely watched 10y-3m.
  • US retail sales for February came significantly lower-than-expected, leading to an initial selloff of USD and risk assets, but the damage was completely unwound after the US ISM PMI. Solid positive revisions to the January numbers helped to add some sweetness to the bitteess.
  • In contrast, Eurozone inflation and German manufacturing data kept disappointing, which is going to keep any residual ECB optimism at bay. The sharp fall in German new orders continues to weight on the manufacturing data series, with Brexit, a reduction in car sales and evidence of a global slowdown the main culprits. The Central Bank is far from being able to justify any shift to its renewed dovish stance for the remainder of 2019 at the very least.
  • The UK govement has rejected all the motions as part of the indicative vote scheme a second time. The UK govement is now scheduled to gather for an emergency meeting to decide the best course of action, which according to a few bank research reports, is likely to involve a political process amid the struggles to reach any type consensus in Parliament. The deadline by the EU to officially cease to stay a member of the bloc is April 12. The options considered include the proposal of a customs union post-Brexit, a second referendum which would likely be the most incendiary action or calling for an early election.
  • China’s Caixin PMI came stronger-than-expected at 50.8, confirming the improved outlook in the Big Panda (China) after the weekend’s positive official govement PMI for the month of March. The green shoots in China were instrumental to see risk assets extend its gains.
  • The UK Manufacturing PMI knocked it out of the park at 55.1 vs 51.2 but most of the gains were driven almost in its entirety by stockpiling, which is due to British corporate provisions that have been effectively put in place in case the UK leaves the EU without a deal.
  • The RBA policy statement kept its neutral mantra, emphasizing the strength of the Australian labor market as one factor that keeps counterbalancing the negative fundamentals stemming from the housing market, consumption and inflation, with the latter being downgraded heading into 2020 to 2.25%.

Recent Economic Indicators & Events Ahead

Source: Forexfactory

RORO – Risk On Risk Off Conditions

Whatever residual angst was left from last week’s US yield curve inversion has now truly dissipated. The S&P 500, as a representation of the state of affairs in global equities, continues to charge higher to defy history by breaking this year’s high and in the process, near a milestone in which a V-shape type of recovery after officially entering a bear market following the 20% fall from its peak last year. If it materializes by breaking the previous record high, it will be one of the fastest comebacks ever, taking as a reference any time in history when a 20% drop from the trend highs had preceded. The selling of bonds globally, with the US 30-year bond our guide, is a manifestation of the improved prospects of a pick up in global activity if China’s PMIs or the US ISM acts as our reference. A very strong 5bp rally in the long-dated 30-year bond yield towards 2.9% which has led the DXY to marginally breakout its prior high above the 97.00 mark. The environment, therefore, is dominated by USD strength across the board in a context of rampant equities. If we take a look at the Yen index (equally weighted vs G8 FX), Oil/Gold ratio, the reduction in the VIX, all paint the same positive picture. The only caveat would be credit markets, where investment grade bond yields have fared better compared to junk bonds, an outcome not ideal when risk appetite is truly present. The current dynamics have set up an environment for the USD to stay in a fortified position, likely to attract further bids, especially if a clear breakout in the DXY eventually transpires, which is a big IF, as every time the index tests new highs, a quick rejection prevents clear breakouts, testament of the absorption of offers in pairs such as the EUR/USD, with strong buying interested still concentrated sub 1.1250.

Pairs To Watch: Intermarket Flows & Technical Analysis

EUR/USD: Break Away From Accumulation Area

The sprint higher by the USD across the board has led to a breakout of a 3-day single volume distribution area. Some caution to play short right off the bat is warranted though, as the violation of the lows is yet to find sufficient acceptance below the series of lows that constituted the bottom of the range. Besides, the breakout is headed straight into the round number of 1.12. With these waings out of the way, fundamentally speaking, and as the German – US bond yield spread is starting to manifest more vividly, capital flows are now added to the equation as yet another reason to stay bearish the exchange rate. Intermarket flows and technical both show us the same direction lower. The fact that most of the volume from Monday is now trapped just under 1.1250 is yet another indication that any rebound should still be perceived as an opportunity to bail by intraday traders. If follow through transpires as part of the bearish trend, I’d expect a break of 1.12 to see a price extension into the 1.1180-85, where the first significant cluster of bids by market-makers at the 100% proj target (1:1 measured move of the range size) should be noted ahead of 1.1150-55.

USD/JPY: Revisits FOMC-Led Supply Imbalance

A renewed impetus in the exchange rate is well and truly alive after a fundamentally-led adjustment in the price, resulting in a fast auction into 111.45-50, where bids meet the origin of a strong supply imbalance dating back March 20th, time when the FOMC admitted a surprisingly dovish stance. Judging by technicals and intermarket flows, the pressure is definitely building up for the market to find a higher equilibrium as bids into the USD keep gathering in congruence with the renewed bullish dynamics across equities, fixed income and the DXY, all endorsing higher levels. Be aware, in terms of risk reward, if trading intraday, 111.45-50 also represents the 100% proj level from the latest measured move taking as reference the previous swing low through the breakout point. Any strategy looking to capitalize on the ongoing bullish momentum would find better levels to engage starting at 111.15-20 (resistance-tued-support), followed by the 111.00 (POC Monday) ahead of 110.85. Commanding the uptrend traders can now find further comfort in the form of a multiple trendlines. Adding to the bullish case going forward, the latest bull cycle has now extended over 138p, as opposed to the first impulsive move up off the bottom, worth only 98p. What this means is that the market structure is developing with the right traits of magnitude to find draw further buying interest.

USD/CAD: Price Lands At Major Confluence 1.33

Not only the bearish move has stopped in its tracks at 1.33 on the basis of being a round number, but there is mounting evidence that the level is a hot spot where a large cluster of bids rest. Whether we measure the 100% proj target through the swing low breakout of 1.3373 or the mini range resolution through 1.3340, the projected target is the same, 1.33, hence adding further credence for a mean reversal movement, at least to retest the broken range bottom at 1.3340. In terms of intermarket flows, it looks as though the strong Canadian GDP from last Friday, alongside the risk on mood, has so far resulted in the CAD defying and counterbalancing the DXY strength, with Oil and the downward trend in the US-CA bond yield spread adding to the case for the slide to keep its course. In light of the hourly bearish structure firmly in place, with ¾ of the March 21 to March 25 gains all but evaporated, and a volume profile where the POC (highest concentration of volume) is found way above circa 1.3350, the outlook for the market remains technically constructive, even if I wouldn’t place all the conviction as this is a trend developing against the DXY, which has proven to be one of the best leading indicators, alongside the fluctuations in the price of Oil.

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