The Daily Edge is authored by Ivan Delgado, 10y Forex Trader veteran & Market Insights Commentator at Global Prime. Feel free to follow Ivan on Twitter & Youtube weekly show. You can also subscribe to the mailing list to receive Ivan’s Daily wrap. The purpose of this content is to provide an assessment of the conditions, taking an in-depth look of market dynamics – fundamentals and technicals – determine daily biases and assist one’s trading decisions.
The Daily Edge is authored by Ivan Delgado, Head of Market Research 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, futures and options, in order to determine daily biases and assist one’s decisions on a regular basis. Feel free to follow Ivan on Twitter & Youtube.
It didn’t take long for Fed’s Chairman Jerome Powell to cave in by sounding more dovish during last Friday’s joint interview alongside former Fed Chairs Beanke and Yellen. The hint that the Central Bank is prepared to adjust its course on QT (quantitative tightening) should market forces continue to determine — via the sell-off in equities — that the rubber has stretched too much, is the theme at play igniting an abrupt reversal seen since Friday.
Also, make no mistake, Fed’s Powell has walked back all this…
Not because Fed’s President Trump has added pressure on the Central Bank’s policies, as much he tried, but because at the end of the day, no one, even Central Banks, can fight the market. It’s been well-telegraphed through the contraction in Oil prices, US asset valuations through the roof, Apple’s downgraded revenue guidance, depressed manufacturing PMIs, an unprecedented global yield curve inversion in many countries, and the list goes on… that the Fed was reaching a plateau in its cycle.
Headlines of the following caliber: Fed will be “patient, prepared with flexible policy” or “wouldn’t hesitate to change balance sheet policy if needed” were music to the ears of bulls and for the overall recovery in risk sentiment.
Will it last? The comments came directly from the horse’s mouth, so I believe they must be respected and they add credence to see further legs up in risk.
After all, one wonders how long was the Fed ready to delay the inevitable “blink” given the obvious disparity between their rate hike dot plot estimates (3 for 2019) and the Fed fund futures (none).
So, while Powell’s hint for concessions in the Fed’s shrinking balance sheet in case of further disruptive market movement is the overarching dominant theme in markets, there is another major development worth noting.
I am talking about the outstanding US payrolls report. It was simply incredible after an increase of 312k jobs, an upward revision of 58k the previous month, an increase in participation (led to a tick up in the unemployment rate) all while wage increases jumped to 0.4% MoM for an annual rate of 3.2% YoY. The take via bank researches was unanimous, it was a big positive.
However, there are a few caveats that are worth outlining for traders not to get ahead of themselves on their bullish views on the US Dollar. Firstly, the US jobs report tends to be a lagging indicator vs other leading measures of which we already had a sour taste last week after a massive decline in the US ISM manufacturing PMI. Take note. Secondly, with no end in sight for a resolution to the US govement shutdown, the prospects for the US job figures in Q1 are far from promising. Thirdly, the market is currently emboldened by a sense of renewed risk appetite, even if the cycle is going to be short in nature, and that places currencies the likes of the USD or JPY on the back foot against beta plays the likes of the Aussie, the Canadian Dollar, the Kiwi, EM FX. Fourthly, the US Treasury is about to add liquidity into the system by reducing its cash holdings due to an anticipated debt ceiling suspension, hence this technical liquidity event is another temporary negative risk for the USD.
Andreas Steno Larsen, Senior Global FX/FI Strategist at Nordea Markets, comments on this underlying risk for the USD in Q1: “The likely upcoming debt ceiling excess liquidity surge is interesting, as liquidity developments will then be at odds with Feds balance sheet trend.” You can access the latest Nordea weekly market research by clicking the following link.
I want to emphasize that as strong as the US NFP may have looked for December, there is a clear risk that the markets, as a discounting mechanism, will gradually be dismissing this positive input, to instead be eclipsed by the underlying signs of a significant contraction in the US economy in H1 ‘19.
This quote, by Nordea’s Andreas, highlights the overwhelming signs of a top reached in the US economic cycle and should be a great reminder that the focus will be firmly maintained in the global growth slowdown front in 2019 and how the US may continue to “catch down” on trends seen elsewhere.
I can’t foresee how the Q4 2018 risk-off profile gets unwound from a macro perspective, hence why we should remain in an environment where all types of asset classes stay under pressure (risk off) in a theme fairly analogous to what’s been the norm in the last few months. In between, we will obviously have to contend with short-term hiccups of risk appetite, as the one currently underway, on the back of the Fed’s stark change of stance in the monetary options that will be on the table during 2019.
It’s important to remember that there is still a lot more room for the Fed to stay sidelined under a thoughtful waiting mode until the day of reckoning comes to announce a radical reversal back into full-fledged easing mode again. They now have some ammunition ready after the completion of a tightening campaign back towards near neutral levels, while also having the comfort of waiting, courtesy of lagging US NFP numbers that are disguising the true forward-looking direr state of the US economy.
Bottom line, the day in which the Fed goes back into full-blown easing mode is still far from materializing, that’s why we should be mindful that short-term, this run on risk should be a bleep or a drop in a red macro ocean. It may last days, but the environment remains a dangerous one and the trend is clear.
The following chart by the Financial Times, speaks volumes about the attractiveness of short-term fixed-income allocations, a reminder that the market is non-committal and the growth outlook severely disregarded.
Source: Financial Times
As Wikipedia explains: “A money market fund (also called a money market mutual fund) is an open-ended mutual fund that invests in short-term debt securities such as US Treasury bills and commercial paper. Money market funds are widely (though not necessarily accurately) regarded as being as safe as bank deposits yet providing a higher yield.”
To fully understand the impending dangers the US and the global economy face in 2019, I highly recommend to read the latest quarterly investor letter Q4 2018 by Crescat Capital, a value-driven global macro hedge fund, which ended last year as one of the top performing funds according to the HFRX Global Hedge Fund Index, a rare occurrence indeed.
Let’s keep moving along. Talking about ammunition, the one Central Bank that finds itself with no tools left to counteract any downside risks in the Eurozone economy is the ECB. The following picture via Kai Pflughaupt, Inter-Market Analyst with twitter handle @MacroTechnicals speaks a thousand words. The Fed is walking a tightrope, but the ECB is really trapped in a massive hole with no way out.
With the European PMIs in full on deterioration mode and last Friday’s EZ CPI undershooting well below the ECB’s mandate as low Oil prices exert downward pressure, the ECB appears to be the next shoe to drop with a more dovish tilt to its forward guidance.
As Bert Colijn, Senior Economist at ING notes: “Even though wage growth has undoubtedly started to improve in the Eurozone and is now back at growth rates seen during the 2000s, this is not yet translating into stronger core inflation. With other input prices weakening and uncertainty about the Eurozone economy increasing, businesses are not yet pricing through the higher wages.”
Morgan Stanley Economics Team remains fairly optimistic that the ECB will be able to navigate through this patch of weakening data:“The mixed print should not affect the ECB’s view on the inflation trajectory. That said, the central bank does not seem to be in any rush to hike rates. We continue to expect the ECB to hike the depo rate in October, with a dovish tilt in the communication of this first hike. It’s likely to be depicted more as a ‘technical adjustment’ to move away from an overly negative policy rate than the start of a hiking cycle.”
But not only the economic indicators in the Euro Area are faltering amid tentative signs of a broader economic slowdown, but the social unrest in France is getting out of control. That’s one of the key reason why I can’t see a breakout of the EUR/USD 1.13–1.15 range anytime soon. The French credit-default swap has been ticking up as of late, a source of conce for markets.
Judge by yourself:
Since global growth has been pinned at the very top of everyone’s list as the hot topic to monitor, we cannot ignore the latest developments in China, the economy that in the last decade, has contributed to half the growth in global GDP! Last Friday, we leaed that amid the country’s unprecedented credit bubble and consistently weaker economic data for the last 2 years, the PBOC announced a cut of 1% to its reserve requirement ratio to ensure greater pockets of liquidity in the system.
Source: Reuters FXWW room
This news out of China, coupled with the blinking of Fed’s Powell, strengthens a short-term thesis in which a recovery in risk asset (micro in nature) within a wider macro risk-off context ensues.
By having a look at the performance of the most risk-sensitive assets, the latest movements are characterized by a classic risk-appetite swing. The risk-weighted index seems to be carving out a temporary short-term bottom (area chart), US bonds were sold the most since Oct 3rd ’18, the S&P 500 printed a commanding bullish outside day while Gold was trounced off 1.3k with the sell-off in the GC futures contract carrying the highest volume since the second week of Oct ‘18.
In the grand scheme of things, the macro trend of global yield curve inversions (bottom left chart) should be a useful reminder that this current risk-on cycle should be short-term in nature and until proven wrong, I believe that at the end, when juxtaposing global growth vs Fed’s dial down on its QT, the former will continue to keep risk assets underperforming macro-wise until the Fed does really commit to reverse course.
By drawing a volume profile from the onset of the eteal daily range between 1.15 and 1.1220, we can extract some valuable insights. We can observe how the majority of the volume ever since late October has been concentrated in a 1 cent range as depicted via the dash lines (1.1330–1.1430). That would be our micro range as guidance. Then we have the macro range delimited by 1.15 to the upside and 1.1270 to the downside. We will disregard the drop on Nov 12 as a one-off event which if accounted for would misrepresent the accuracy of the range measurement.
We can also see how the POC is found circa 1.14, which carries a fairly strong message, as it communicates than after months of interactions within the confined range, the perceived fair value within the range is largely skewed towards the upside. This strengthens the notion that any revisit of the lower end of the range, between 1.1330 and 1.1270 should continue to offer buy-side opportunities as has been the case throughout the duration of the range (see magenta arrows). Similarly, the interactions between 1.1430 and 1.15, given the weakening economic trends in the EZ, should continue to provide formidable selling opportunities, even if my conviction, due to the potential reversion in Fed’s policies and the German vs US yield spread, is not as strong.
If you, like me, believe that the Sterling cannot possibly justify a break outside its macro range, which now I perceive to be between 1.28 and 1.25, until the Brexit situation clears up, then you’d probably agree that the Sterling is fast approaching an area of high interest to be a seller on strength. I’ve drawn the POC (Point of Control) that represents the highest accumulation of volume through Oct/Nov to highlight how stiff this resistance should become for a currency that keeps surging as a function of USD weakness and vague hope that the anticipated defeat of the UK May’s Brexit deal as part of the meaningful vote may lead to a second referendum vote or a general election being called as the next step. Hard to see any risk-reward to be a high timeframe buyer here unless you really are betting for a breakout of the EURUSD range or 2nd referendum.
It hasn’t really mattered whether or not the ratio of the S&P 500 / Gold kept falling, the Aussie has shown extreme resilience to reject lower levels. The trap of volume circa 7050 with the 5-day MA now tuing bullish, which is a sign of short-term positive momentum, does suggest that we are in the midst of a buy-side campaign until the short-term target of 7170 is achieved and buyers can start finding sufficient pockets of liquidity to close their short-term long exposure as macro accounts are likely to step back into sell-side interest. For now, I am a buyer on weakness, with my order waiting to be filled on a retracement back towards 7060.
As I was scanning through my markets today, I feel compelled to report on what’s potentially a short-term opportunity to capitalize on the strength on the Aussie, this time vs the Euro. As the Fed Put is out of Powell’s hat, coupled with China’s easier policies, this has induced a short-term change in market dynamics, which is being supported by EUR/AUD technicals too. The price has broken below its previous swing low, with the VIX and the German vs Aus yield spreads moving in tandem to favor the downside momentum in the pair. However, with the move looking overstretched, the best play here appears to be engaging in relief rallies above the 1.61/6150 area.
* The 25-delta risk reversal is the result of calculating the vol of the 25 delta call and discount the vol of the 25 delta put. … A positive risk reversal (calls vol greater than puts) implies a ‘positively’ skewed distribution, in other words, an underperformance of longs via spot. The analysis of the 25-delta risk reversals, when combined with different time measures of implied volatility, allows us to factor in more clues about a potential direction. If the day to day pricing of calls — puts increases while there is an anticipation of greater vol, it tends to be a bullish signal to expect higher spot prices.
Source: http://cmegroup.quikstrike.net (The RR settles are ready~1am UK).
Find below today’s implied / historical vol levels. Are we entering a regime of higher vol in the Australian and New Zealand Dollar? According to the ratios seen, it looks like we may transition from a protracted gamma — scalping market profile to much slipper price action in coming weeks.
* If implied vol is below historical vol, represented by a ratio < 1% in the table above, the market tends to seek equilibrium by being long vega (volatility) via the buying of options. This is when gamma scalping is most present to keep positions delta neutral, which tends to result in markets more trappy/rotational. On the contrary, if implied vol is above historical vol, represented by a ratio > 1%, we are faced with a market that carries more unlimited risks given the increased activity to sell expensive volatility (puts), hence why it tends to result in a more directional market profile when breaks occur. The sellers of puts must hedge their risk by selling on bearish breakouts and vice versa.
Soon you will be able to subscribe to receive ‘the daily edge’. In the meantime, feel free to follow Ivan on Twitter.