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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.
In the last 24h, we’ve seen an aggressive sell-off in risk assets, in what I categorize based on my risk model as classic risk aversion. The DXY was by a country mile the outperformer on Tuesday.
The immediate outlook for the Euro has been damaged, even if a confluent area of support on the hourly still offers certain credence for buyers to still find technical value engaging in weakness.
The Sterling is piggybacking the performance in the EUR/USD while awaiting new cues out of the Brexit conundrum. The USD/JPY is going to face tough hurdles through 113.00/113.10 if the recovery keeps extending. On the Aussie front, the pair has been punished on risk-off flows and it looks like an interesting proposition to buy on weakness but make sure to keep an eye on equities performance.
In my usual market scan, I’ve also spotted an attractive long play in the AUD/CAD based on valuations, and a similar trade might be in store, judging by the divergence in yield spread, in favor of the Kiwi. The short call on EUR/JPY yesterday played out well.
The risk-weighted index has taken another harsh beating, this time courtesy of what I call a classic ‘risk-off’ scenario, which refers to lower yields and stocks and a higher USD as a safe haven. It, therefore, leaves us with an ugly picture in the short-term, while from a structural point, it doesn’t get any better. We still remain in a weak USD context as depicted by the black lines in the DXY chart. Either way, if the DXY were to keep breaking higher unless we see a major tuaround in equities, the bottom line is that market conditions appear far from conducive to bid risk assets.
On a chart by chart basis, let’s first dissect the rout we’ve seen in the S&P 500 as the sell-off extended. There is little reason to believe the index won’t fall further until it reaches its next 100% proj level at 2,600.00, which happens to coincide with a weekly level of support and where we might see a short-term termination of the sell-side flows before a more meaningful rebound. The junk bonds index* (HYG) suggests more pain ahead.
*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.
US yields deserve some closer examination as we are at an area on the daily where I believe we might start to see some recovery. Not only on the premise of the static support but on the inability of the 30-yr yield in the US to close under level despite a deep break. At this stage, this is just a tentative forecast, nothing else.
We still need to see rates recover at least the 3.35% area and find acceptance above before we can start making a stronger case. If this scenario were to be combined with the breakout of the descending trendline in the DXY with acceptance found above the 97.00 area, watch for a transition from USD weakness into strength across the board. As the cycles stand though, there is more work to be done by USD bulls before order flows and the structure can align.
While keeping the weekly bullish outside candle present in our minds, I must say that the ferocious bearish daily outside day has now shifted the focus very short term towards 1.1310/1.13 based on the areas of high interest in the daily chart.
On the hourly, a huge level of confluence comes now into focus at 1.1350/55, where a buy-side campaign may be initiated. A break below exposes 1.1316 (Tuesday’s POC) ahead of 1.1270.A consolidation below 1.1316 on the hourly or a break sub 1.13 is needed to shift the outlook towards new cycle lows.However, if that were to be the case, based on the weakening cycles down, I can’t help but think this would constitute an interest buying proposition.
Yesterday, I made a case that if we kept breaking higher with the German vs Italian yield spread so depressed, it may have suggested that the market was placing the Italian conces on the backbuer short term as new thematics (Oil, Fed hikes) and familiar ones (Brexit, China trade) come to the forefront. At the end of the day, it wasn’t the case and looks like the sell-off in the EUR also has behind as a driver a component of fear amid the blow out of Italian yields.
The Sterling, amid low activity in the Brexit front, has been driven as a function of the outperformance in the DXY. A quick look at the higher timeframes (weekly, daily) and few would argue the weekly support ahead of 1.27 looks like a reasonable next target.
By drilling down further into the hourly flows and structures, we can see how the level of resistance, which had been attacked on a tapering of volumes, has held firm. The current structure of this market is clearly pointing at potentially 1.27 too, as the next target. A break below opens up the doors to 1.2590 based on a 100% projection from the breakout point at 1.27.
By scanning through both the yield spread and the DXY, this market has all signs written on the wall that further pushes down are perfectly justified based on valuations. One, however, must account for the political risk in the UK surrounding the Brexit negotiations.
The recovery in the pair is set to face a major battle between 113.00/113.10, where a confluent high-interest area comes at. On the hourly, it’d constitute a test of resistance within the context of 2 pushes down, so theoretically, we would still be missing a final 3rd push to the downside. The bearish outside weekly candle supports the notion of a bearish extension for now.
From a valuation perspective, the risk-off conditions witnessed this week should play out well into the hands of sellers. Also note, the US vs JP 5-yr yield spread, as a barometer of risk and the Fed’s rates outlook, has made lower lows while the pair is still dealt well above its previous swing low of 111.50. Same applies for the risk index (in black line), making new lows yet the price is diverging.
From a daily perspective, I still perceive this market as a buy on dips, although more prudence is warranted after the sizeable bearish candle closed at the very lows of the day (no profit-taking). I got filled a long position but the close of the candle suggests some adjustment in risk. I still like to buy it at the 70% retrac with the daily cycle still in favor, so happy to give it a shot.
On the hourly chart, sellers have taken over after the breakout of the structure at 0.7250, which suggests that any recovery should find a major wall of offers at the mentioned level. A break above would then expose the next target of 0.7295/0.73. To the downside, if the downside momentum finds new legs, the 100% proj target can be found at the 0.7166, where a level of hourly support interests.
From a valuation standpoint, the AU vs US yield spread does argue for buy on dips to still be justified. Notice how strong the correlation on a 10-period has been. On the flip side, the sell-off in the Hang Send does send us some waing signs as the index rolls over and I must say, the correlation it has shown vs the AUD is very strong.
Yesterday, I argued for an interesting proposition to short the EUR/JPY at a critical area proven to be very sticky. What made the trade very compelling was the divergence between the discounted price + the behavior we had seen as of late in both the risk-weighted index and the German vs Japan yield spread. We were definitely selling into value at these levels. The trade has played out well in the sellers’ favor in a rather fast fashion.
Here is another interesting pair to watch today. An analogous discounted price situation can be found in AUD/CAD today. Watch pullbacks, esp into 9560 –> AU vs CA yield at highs of cycle / Oil hammered / Stable uptrend the last 30d.
If we re-anchor value to the most recent level of reference where decisions will be made, I’d say buying dips on NZD/USD is also justified. The yield correlation is as strong as it gets. Value out of whack post risk-off flows. However, be aware that rather than catching a knife, wait for some type of tuaround evidence.
How worried shall we be? Volatility in stocks, junk bond yields on the rise, funding costs higher, all signs of tightening of financial conditions. A recession may occur (33% odds) says JP Morgan.
According to Goldman Sachs, Europe’s acceleration in activity faded this year as the impulse from past growth tailwinds faded. What will be the spillover effects of more pessimistic growth forecasts for the rate hike expectations by the ECB in 2019?
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