The Daily Edge

True Risk Off As Trump Flexes Muscle On Mexico

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

Mr. Market made one of the most commanding moves as part of the month-long risk aversion chapter we are so deeply entrenched into by sending the Yen sky high in response by yet again more retaliatory soundbites by US President Trump, this time announcing that Mexico is next up to be taxed on all imports. In a matter of days, with both sides scheduled to meet this Wednesday for talks, we will find out if Trump is bluffing or he really means it, as you never know what to expect. Nonetheless, the latest Mexican developments acted as the nail in the coffin in the terrible performance in risk-sensitive assets such as the S&P 500 or US yields during May, the latter signaling the Fed should start to seriously consider accommodative policies as we head into H2, a scenario Fed Vice Chair Clarida gently hinted on last week. But leaving Mexico aside, the dominant driving factor continues to be the escalating US-China trade tension, with the latter making its posture even more explicit after the publication of a White Paper, essentially telling the US that they are ready to have a long fight if necessary. A game of chicken with no end in sight. After all said and done, the crosscurrents in the currency market saw the USD hit the hardest in the G10 space (aside from MXN and CNH), while the CAD also suffered equally harsh selling pressure on mounting negative inputs (GDP, Oil …). The Euro showed a combatant stance as did the AUD, with both currencies facing its respective Central Bank policy meetings this week. The AUD will gaer most of the attention as the RBA is set to finally end its long-held thoughtful wait by announcing its first rate cut in years while the ECB is set to stay cautiously sidelined on new measures.

Narratives In Financial Markets

* The Information is gathered after scanning top publications including the FT, WSJ, Reuters, Bloomberg, ForexLive, Institutional Bank Research reports.

  • The bond yield market rout carries on as Trump announces escalating tariffs on Mexico due to immigration at the border, leading to a major wave of risk-off flows into the Yen and Franc. Trump said it’s time for $100 billion trade deficit with Mexico to end, hence why he’s planning to impose a 5% tariff on all imported goods from Mexico beginning June 10, even threatening to “gradually increase” it until the flow of undocumented immigrants at the border stopped.
  • Mexican President said the chance of no deal on border dispute a remote possibility, noting that Mexican and US officials are scheduled to meet on Wednesday. Nonetheless, Trump keeps playing with fire on the game of tariffs, which may sooner or later backfire by creating real long-lasting trade wars until a transition in the US govement occurs.
  • As Bloomberg reports, China’s govement says it’s willing to work with the US to end an escalating trade war but blames President Trump’s administration for the collapse in talks and won’t be pressured into concessions, according to a white paper published on Sunday.
  • US VP Pence is scheduled to give a controversial speech about China’s religious freedoms and human rights by mid-June, in commemoration of the 30th anniversary of Tiananmen Square, which could easily fuel further discontent by China’s ruling communist party.
  • The retaliatory tit for tat stance between the US and China after the Huawei ban keeps on going as it’s now the tu of the latter to announce they are planning to set up an ‘unreliable entities’ list to combat foreign firms that cut supplies and act against China’s best interest. Besides, China has prepared its plan to limit rare earth exports to the US, as needed.
  • The decision by Trump on Mexico, if it doesn’t tu out to be a bluff, is a worrisome message for any other nation, including China, that aims to engage in negotiations in good with the US. In other words, the measures against Mexico may lead China to further distrust the US intentions, therefore making the slim chances of a deal in the G20 even more minuscule.
  • Judging by the dramatic fall in US yields, the Fed is no longer in a position where it can shrug off the prospects of lower rates in H2, making this Tuesday’s speech by Fed’s Chair Powell another opportunity for the market to pick on his thinking. He is likely to sound non-committal even if the Fed’s favorite yield curve (3m-10y) is telling us more stimulus is coming unless there is a surprising U-tu in the trade relationships between the US and China.
  • Several reports suggest that the US Chamber of Commerce is looking at a legal challenge to US tariffs on Mexico. Groups engaged in the discussions are hoping to shed a light by Monday.
  • US April PCE core came at +1.6% y/y vs +1.6% expected. By breaking down the report, there were some glimpses of hope as the consumer showed stronger spending appetite.
  • Canada Q1 GDP came at 0.4% annualized vs 0.7% estimate, which combined with the ongoing massacre of Oil longs, together with the contagion fears of the Mexican tariffs with Canada potentially next on the list, it led to continuous heavy supply flows in the Canadian Dollar.
  • China’s PMI readings saw a terrible outcome at 49.4 vs 50 exp, and as reported by Forexlive, not only was a miss but it came in below all estimates (from the Bloomberg survey). The Caixin Manufacturing PMI on Monday will be another chance to take a pulse of the Chinese economy.

Recent Economic Indicators & Events Ahead

Source: Forexfactory

RORO (Risk On, Risk Off Conditions)

The one-way street fall in US yields and the DXY comes in response to a market spooked by the latest threat by US President Trump to tax all import goods from Mexico. The bold move by Trump, indirectly, has the market discounting that China will be, at the very least, further disillusioned about the prospects of pursuing a comprehensive trade deal with the US in the first place. Mexico spent over 1 year negotiating the ratification of a modified NAFTA agreement only to receive this reprimand by Trump over border issues, so the Chinese may be asking themselves, why bother? Through the eyes of China, this new chapter against Mexico is mounting evidence of how dicey the environment can be when trying to talk serious business with the Trump administration. The bottom line is that the more signs of trade disputes in existence with no end in sight, with China at the forefront, the more the market is set to selloff to adjust its true valuation. Let’s not forget that a large part of the epic recovery rally in risk through Q1 came on the basis of a high degree of certainty, to the point of being fully priced, that the US and China would ink a deal. Every day, we seem to be moving further apart from that anticipated event, hence why the risk off remains well justified. It doesn’t matter what asset class one looks at, the message is unambiguously clear. The deleveraging phase is well and alive, and the closes in risk assets, from the S&P 500, through the US 30y bond yield, to the Japanese Yen index, all suggest a market with a null appetite to catch a falling knife.

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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