False Sense Of Risk Recovery In Markets
The Daily Edge

False Sense Of Risk Recovery In Markets

Authored by Ivan Delgado

Ivan Delgado is a decade-long Forex Trader. Feel free to follow Ivan on Youtube. Join thousands of traders who follow Ivan's insights to increase their profitability rate by learning the ins and outs of how to read and trade financial markets. Ivan has you covered with in-depth technical market analysis to help you turn the corner.

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

Tuesday’s tuaround in risk dynamics should not send the false signal to think we are anywhere near from being out of the woods. The crosscurrents in equities, fixed income credit and currencies, specifically the performance of the USD, JPY, CNH suggest the dominant thematic of ‘risk off’ is not going away, or at least, there is no evidence yet. The disparity in performance between the Yen and the rest of G10 FX should be the first reminder every day one opens the charts to the degree in which financial conditions have deteriorated. The USD and CAD did well on Tuesday, the latter regaining its lost appeal after the best Canadian jobs report in recorded history last Friday. The Euro is starting to wane a tad as the German data remains underwhelming to say the least, with today’s European preliminary GDPs, including Germany, another major test. The AUD & NZD, amid the dicey US-China trade dispute, remain on the backfoot, while the Sterling keeps suffering pains of its own as the political stalemate on Brexit continues.

Narratives In Financial Markets

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

  • A relief rally in US risk assets materialized, even if we are far from ‘Goldilocks’ risk appetite dynamics pre US-China trade crisis. Our RORO (risk on, risk off model) warrants caution amid a suppressed Yuan and bearish Chinese equities (barometers of capital flights from China).
  • US President Trump threw a few positive headlines that so far have had a positive effect in the price of riskier assets such as equities, taking the VIX down towards 18.00. Trump told reporters “we’ll let you know in 3-4 weeks if trade talks are successful but I have a feeling it’s going to be very successful”, in what’s a clear attempt to talk up depressed equities.
  • Trump made some extra remarks to play down the trade tensions with China by saying that the relationship with China’s Xi is extraordinary or referring to the trade dispute as a little squabble, reassuring the media that the talks have not collapsed. The comments underpinned markets.
  • Further anchoring the correction in equities was the headline that Mnuchin may visit China ‘soon’ in an attempt to resume the trade talks, according to his spokesman. There was no mention of China’s hawk Lighthizer as planning to join the trip this time.
  • Trump took another swipe at the Fed, noting that “China will be pumping money into their system and probably reducing rates, in order to make up for the business they’ll be losing. If the Fed ever did a ‘match’, it’d be game over, we win! In any event, China wants a deal”.
  • China’s Foreign Ministry has come forward to deny the US accusations of China riddling the trade draft agreement by noting that the US made last-minute demands to ramp up the purchase of US goods by China, adding that in no case China violated promises made. A report by the Financial Times supports the claims by China that it was the US that wanted a sudden increase in the amount of purchases of goods by China.
  • Take headlines by US Trump with a bucket of salt, as the US aims to talk up markets. However, from the Chinese camp, while playing a soft hand so far, they’ve reiterated they are not afraid of a trade war, urging the US to not underestimate China’s determination to protect its interest.
  • Italy’s Salvini threatened the EU that if Italy has to break away from previous budget agreements in order to lower the Italian unemployment rate, they will do so without hesitation. If the limits to break is the 3% deficit to GDP or 130-140% debt to GDP, they are ready.
  • US April import price index, excluding Petroleum, saw a major miss of -0.6% vs +0.2%, matching the same negative print as last December, both the lowest since late 2014. It does communicate that the slowdown in the global economy may be influencing the pricing.
  • Geopolitical tensions in the Middle East, where Saudi Aramco pumping stations came under attack by drones, thought to be orchestrated by Yemen’s Houthis, keep underpinning the price of Oil. The Saudi Oil Minister has announced the temporary shutdown of the East-West pipeline as a precautionary measure, hence rising prospects of supply disruptions.
  • The German May ZEW survey saw a tiny recovery in the current situation to 8.2 vs 6.3 exp, while the economic sentiment series dropped substantially to -2.1 vs 5.1 exp. The negative news that keep coming out of Germany is going to continue limiting the appeal towards the Euro as the ECB remains accommodative.
  • China’s data dump came on the soft side, punishing the Aussie further. The data for April was underwhelming across the board, with the fixed asset investment y/y at 6.1% vs 6.4% exp, the April industrial production y/y at 5.4% vs 6.5% exp, while retail sales y/y undershot at 7.2% vs 8.6% exp.
  • Today’s economic calendar offers key events such as the German and EU preliminary GDP readings, the US retail sales or Canada’s inflation numbers. Volatility is expected to stay rather elevated in equities, while the FX market should get its fair share of stimulus via the data + US-China trade headlines.

Recent Economic Indicators & Events Ahead

Source: Forexfactory

RORO (Risk On, Risk Off Conditions)

The risk environment saw a relief intraday rally, which while meritorious on its own right due to the dicey US-China trade dispute, is far from reassuring in terms of thinking we are out of the woods. The S&P 500, as the reference to assess the appeal back into stocks, has seen the micro momentum tu high as the slope of the 25-HMA depicts, even if it should be perceived as a poor quality run on the basis that it is fighting the bearish macro trend (125-HMA slope) and the bearish structure. The US 30-year bond yield, as another leading indicator of risk conditions, trades around 2.85% after very tepid movement near trend lows, which again, is not a positive signal.

The improvement in buy side flows back into the DXY, alongside a broadly bid JPY index, is another reason to be worried that we are lacking sufficient evidence to expect this relief rally to be sustainable. But no other markets provide the degree of evidence to play down Tuesday’s risk recovery as do the Shanghai Composite and the USD/CNH, especially the latter, which keeps pressing higher en route to 7.00. As a rule of thumb, the lower the Yuan goes, the more pessimism exists that the US-China trade stalemate will be resolved anytime soon. Capital flights from China are playing a key role in the depreciation. Besides, with the VIX trading at a level not far from 20.00, I can’t see investors finding much comfort, something already translated in the suppressed valuations of junk bonds (HYG), near-trend lows.

Overall, this marginal gyration in risk is far from acting as an indication that the underlying ‘risk off’ tide is tuing.

Latest Key Developments In FX (Technicals, Fundamentals, Intermarket)

EUR/USD: Bearish Cycle Into Strong Demand

The exchange rate offers a mixed-bag outlook. On one hand, we’ve seen a back-to-back day of a supply imbalance, resulting in the formation of a second leg down. However, the bearish momentum has stopped on its track at a crucial decision point at 1.12-1205 (retest demand May 9th), where a cluster of bids is causing absorption of offers as depicted by the compression of the price. The current support is a potential candidate area where the active bearish cycle may terminate. The backdrop is not the most encouraging for buyers though, as they will have to fight a double distribution down, making the prospects of a retu to a bullish bias a tall order as the rate will have to first clear the 1.1220 resistance level and the descending trendline with acceptance above.

GBP/USD: Bear Trend Firmly In Place

All the technical indications point to an extension of the bearish trend, with one exception, that is, the drop in the exchange rate has now reached the 100% measured target from the former range, an area where profit-taking activity occurs as market makers step in to attempt rotations back to the mean. So far, the supply imbalance amid no progress in Brexit has been the dominant thematic, as clearly manifested via the double distribution down day. There will be a handful of resistance the Sterling must re-take to improve its outlook, from yesterday’s POC, the 1.12920-25 resistance line, which if above, may see the potential capitalization of further upside into the 1.2940-45 resistance line. The OBV (On Balance Volume) holds an unambiguously bearish slope as sell-side volume dominates.

USD/JPY: Retakes Key Line at 109.50

The P-shaped volume profile constitutes a bullish development, one that now hinges on the ability of buyers to maintain the price above the 109.45-50 to avoid a resumption of the dominant trend. If buyers can start building upon the recent momentum by breaking through 109.75-80 resistance, that’s going to expose not only 111.00 round number, but it will damage the higher timeframe bearish bias, as sellers will lose the advantage of protecting the midpoint of the former range. Alteatively, a move down and acceptance back sub 109.45-50 shifts the focus down to 109.00-10. For now, the OBV indicates buy side pressure dominates, while the intermarket flows (DXY + RORO line) suggest that the recovery we’ve seen is congruent with the pick up in the pair’s valuation.

AUD/USD: Selling Bias PiggyBacking the Yuan

The downtrend, even if not supported by the aggregated volume pressure, is clearly bearish. This is an outlook that is also being promoted via a lower Yuan and higher DXY. The fact that the volume accumulation, as represented by the OBV (thick orange line) is trending higher, it indicates a market very well capped by sell-side limit orders, that’s the only way we can be trending down yet the aggregate volume shows the buyers being the side most actively on the bid. The last resolution below 0.6935 low has opened up the doors towards 0.6920 as the next 100% target measure, while on the upside, any recovery should find it problematic to break the POC of the last 48h circa 0.6940-45.

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 in 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 validity of a new cycle being created. Therefore, these trendline drawn in the chart hinges 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