Posted on: 11 Jul, 2019
Powell’s statement was dominated by clear dovish connotations, reiterating that uncertainties continued to dim the US economic outlook due to trading concerns and a global economic slowdown.
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Fed’s Powell testimony in front of the House Financial Services Committee left almost no room for doubt that the Central Bank is setting the stage for a very well-telegraphed 25bp insurance cut on July 31st, as the CME Fedwatch tool indicates. Even chances of a 50bp cut, which looks like a far-fetched scenario even to Fed’s perma dovish member Bullard, has also gone up to 26%.
If Powell had the intention to flip flop the intended easing action the Fed will embark upon this July on the heels of the strong US payrolls and the prevention of a radical escalation in the trade war via a half-hearted US-China trade truce at the G20, he would have done so. But Powell clearly didn't.
Instead, Fed Chair Powell’s prepared statement was dominated by clear dovish connotations, reiterating that uncertainties since the June FOMC continued to dim the US economic outlook driven by trading concerns and a global economic slowdown. On the topic of the protracted low inflation we are seeing, Powell shifted into a higher gear of rhetoric intensity by warning that there is a risk weak inflation will be even more persistent than Fed currently anticipates.
The market was re-emboldened by the fact that Powell had not interfered with the original dovish message from a few weeks’ time. There seems to be therefore little question on market participants’ minds now that Powell’s codewords “an ounce of prevention is worth a pound of cure” in the June FOMC should indeed be interpreted as an immediate insurance cut baked in the cake on the basis of US trade policy uncertainties, low inflation, slowdown in global growth, and risks of lower US economic activity.
Additionally, Powell has clearly strengthened the case, in the market's view, for two more cuts thereafter at each of the following two meetings (Sep17-18 and Oct 29-30) for a cumulative of 75bp of easing for 2019. Below is a chart by Brent Donnelly, Spot FX Trader at HSBC, who touches on why the Fed is keeping a firm hand on its intention to ease.
Amid the avalanche of headlines by Powell, the FOMC June minutes did confirm what the market has already priced in and Powell’s testimony endorsed, which is that a July rate cut seems a done deal. One of the most clarifying headlines as part of the minutes could read that “many fed officials saw stronger rate cut case amid rising risks”, which again, is very consistent with the central dovish thematic that was revealed during today’s Fed Chair Powell testimony.
After all said and done, and as the dust settled, the flurry of trading activity, as our equally weighted currency strength meter illustrates, led to Kiwi, Aussie, Euro and Swissy longs, in this order, to blare the trumpets by putting on the best performances, while the US Dollar was taken to the woodshed.
The fact that the USD was unable to suck in the stampede of capital hitting the offer is a reflection of a more dovish-than-anticipated outcome. As a heads up, the reassurance that an easing cycle by the Fed is being cooked, alongside the relatively expensive USD if one accounts for today’s revelations, makes the USD a serious contender to see follow-through weakness into the second half of the week. Meanwhile, the Pound and the Yen, in aggregate terms, traded relatively idle.
Stay on the watch for the Yen to struggle on Thursday, with a clear risk of fading any strength through Asian hours, should stocks and bonds keep the ‘true risk on’ inertia. Opportunities to be a Yen seller on any intraday strength hold value. This view is supported by the notion that the JPY index printed a doji-type candle yet both the S&P 500 and US bonds communicate Yen is not an attractive vehicle to diversify into as Intermarket flows stand. This could translate in long opportunities in pairs the likes of AUD, NZD, CAD, EUR vs JPY during Thursday’s trading.
A special mention deserves the Canadian Dollar, which proved for the zillion time to be stubbornly well-underpinned by market forces. The BoC meeting, overall, kept the door for further rate cuts temporarily sealed, with Governor Poloz noting that “until headwinds show signs of dissipating or worsen, we are content with today's setting of interest rates”. In a world of a race to the bottom when it comes to easing practices, this is a big deal! The initial selloff in the CAD to wipe out weak-long, as algos reacted to gloomier headlines the likes of “the outlook for the economy is clouded by persistent trade tensions, proved a flash in the pan nonetheless.
The bearish engulfing bar on the USD/CAD embodies the defeat by USD longs and the control that the CAD continues to exert against the former, even if as I’ve pointed out this week, the Canadian currency has reached a monumental macro level of support at the 100% proj target. Still, if there is a driver that has the ability to keep the trend going, that’s the seldom episode we are seeing by which Fed and BoC policies are temporarily diverging in favor of the latter. The blue line in the chart below (US-CA 5y bond yield spread) depicts the ‘divergence’ story.
But it wasn’t the only commanding engulfing candle in the charts. The one printed in the NZD/USD, breaking back above the 13-EMA baseline with an increase in volume, a NZ-US bond yield spread expanding to the upside, coupled with a bullish market structure, is a juicy signal to consider in order to capitalize on further USD weakness. An added plus is that the landscape of risk events faces the only hurdle of Thursday’s US CPI to potentially shift the tide, even if an upside surprise above +0.2% m/m, which is the outcome that may shake the ground in favor of sustained USD buy flows, doesn’t occur since Feb ‘18.
A market riped to see further upside is Gold, which has played like no other expectations for a resumption of a global easing trend by Central Banks. The aggregated negative-yielding bonds around the globe have reached insane levels beyond $13 trillion, which has proven to be strongly synced with an increase in the appeal to hold the yellow metal. Moreover, since the Fed appears to be now leading the pack of Central Banks that will keep the ‘easing show’ going, closely followed by the ECB, taking the baton from the RBA, the plummeting of the nominal US yields alone is an added catalyst for Gold to do well across the board.
Other than the USD, in the digital currency space, the testimony by Powell claimed a second victim. I am referring to Bitcoin as the price skid down from $13k over 1.5k on the way to create another dreadful bearish engulfing bar with the second largest sell-side volume seen since the bull run began.
The euphoria in Bitcoin’s trend has been, by and large, invigorated further by Facebook’s plans to launch a global cryptocurrency (Libra). However, the positive buzz may be about to take a pause as the Fed chair said “Libra raises serious concerns regarding privacy, money laundering, consumer protection, financial stability,” with the comments that followed even more blatantly obvious of the hurdles to be faced ahead by adding that the project “cannot go forward” without broad satisfaction with Facebook’s answers to regulators’ questions. The central bank has set up a “working group” to focus on these unanswered questions.
Moving on, another pair of headlines I picked up on that must command a trader’s attention is the story carried by China’s South China Morning Post, where further revelations on the conversations US President Trump had with his counterpart Xi at the G20 came to the surface. It essentially boiled down to US President Trump repeatedly pressing Xi to commit to purchasing further US agricultural goods with Xi refusing to make specific commitment. Again, this is not a surprise as the trade truce is one that appears to be built on a house of cards ready to collapse. If it hasn’t yet is because its in both countries’ best interest to buy some time.
Remember, White House Kudlow has taken a more lucid turn by finally admitting, in an interview via CNBC’s Capital Exchange, that the US and China may never reach a trade deal due to the difficulty in resolving the remaining issues, which as we know, revolt around technological transfers, intellectual property rights and accountability mechanisms. "When you get down to the last 10 percent, seven-yard line, it's tough," Kudlow said, referring to the negotiations.
For the most optimistic bunch out there, still holding their breath hoping for a positive resolution, the White House, in an official statement, said that there had been a trade call between US and Chinese officials which was defined as constructive. The phone call included US Trade Representative Robert Lighthizer, Treasury Secretary Steven Mnuchin, Chinese Vice Premier Liu He and Minister Zhong Shan. We shall see but looks like a long and arduous 10%.
In the exotic category, I wanted to bring the reader’s attention to the USD/MXN, which this week saw yet again another test of a key horizontal level with a divergence on its intrinsic value line. Granted, Mexico's finance minister resignation on Tuesday over disagreements with regards to economic policy decisions happened to be the main driver overshooting price. But, as I succinctly explained in the following article (How Can The Yuan Help To Puzzle Together USD/MXN Value Trades?), a value-led trading approach when trading the Mexican Peso this year would have led to some incredible opportunities as the chart below demonstrates.
Excerpt from the educational article I shared to clients earlier this week: “Once a retest of the area occurs (highlighted by a vertical line), ask yourself if a divergence with the value line is present from the first time the area was formed. That’s what I’ve highlighted in purple arrows in the chart. If so, this is a communication that the risk is for the pair to fade the breakout as Intermarket flows are not supporting the overall bias. Out of 10 trades that would have been entered, with the exception of trade 4, which overshot the resistance and may have led to a potential loss, the rest of retests were clear failures to enter a trade at a discount.
I hope you found value in today’s decoding of the forex swings. Don’t forget that lining up next this Thursday is the ECB policy decision minutes, the US CPI readings and the second day of Fed Chair Powell testimony, this time in front of the Senate banking panel. Trade safe!
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