Posted on: 20 Dec, 2018
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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.
The Bank of England (BoE) is in no rush to make any changes in policy and it is set to keep the Bank Rate unchanged. Besides, the meeting is not attracting a whole lot of attention as it’s an interim one not followed by an Inflation Report, therefore we should not expect any new developments of interest. The BoE is in a wait-and-see, but not precisely on data-dependency as the ECB or the FED, but rather they’ve been taken partly hostage until Brexit clears up.
Risk continues to be punished severely after the risk-weighted index lost another 3% on the aftermath of the less dovish rate hike by the Federal Reserve. The combination of a trounced S&P 500, along with the hammering of US bond yields to a new cycle low of 2.78% was the perfect risk-off storm.
By looking at the anatomy of Wed’s sell-off in the S&P 500, we saw renewed sell-side commitment on increasing volume, way above the 20-day MA. The price action also screams more trouble ahead, with the selling only finding a temporary base on the touch of the 2,500 major psychological number. The free-fall in the junk bond market (HYG) shows no end in sight, while a hefty VIX above 25.00 is very troublesome. To make matters even worse, the US yield curve dropped mercilessly, with the 10y-2y at 0.11bp, while the Fed’s fav measure 10y-3m is at 0.43bp
The outlook for the 10-yr US bond has also worsened, even if one must be extremely vigilant as the yield, currently at 2.78%, just landed into what signifies a major support area. The violent move, with an increase in volume heading into the level, does suggest that the downside pressure may persist. Meanwhile, the US Dollar continues to be boxed in within a rising wedge on the daily. Until the pattern finds a resolution either way, movements in equities and yields will be far more important to determine the state of affairs when it comes to the risk profile.
The bullish tendencies in the pricing of the pair came to an abrupt halt at the key 1.1435–40 resistance after the Federal Reserve delivered a less dovish rate hike, leading to a major removal of downside liquidity immediately after the event. The daily chart still provides an unambiguous bullish macro backdrop, even if the back-to-back daily topside rejections, accompanied by the intraday impulsive move down clouds the outlook for the pair short-term.
I must say that we are experiencing an unprecedented and very prolonged compression in this pair. Be prepared for volatility to pick up substantially on a breakout. For now, imp vols via options do suggest gamma scalping at the edges of the broad range should continue to ensure familiar levels.
Let’s be clear. Sellers have gained ground, but structurally wise, the battle is not yet lost by buyers, as the cycle of higher highs and higher lows is still intact. The sell-side flows managed to absorb Tuesday’s POC, but residual demand at 1.1350–55 still needs to be cleared before the structure turns bearish on the hourly time frame. On the upside, the clustering of offers around 1.14 (POC Wed) must contain further appreciations or else 1.1420 (origin supply imbalance post-Fed) is next up, in which case, the risk of an upside breakout would be a realistic outcome to expect.
We continue to see the contrast of opposing forces. On one hand, the yield spread valuation does scream to buy this market as the widening continues. However, the moment we stare at the daily price action, it’s almost the dreamed setups to engage in further selling following two pin bar rejections off 1.2680–1.27, an area that I’ve consistently highlighted as a major cluster of offers where trend traders may be looking to engage with impetus on the back of the weekly close sub 1.27.
On the hourly, the bullish structure is the Pound has been semi-compromised by the transition into ranging conditions. If the cluster of bids fails to absorb the increasing sell-side pressure post the FOMC, the Sterling risks a renewed directional bias to the downside. The exchange rate is resting at a critical intersection, represented by a horizontal line + 3rd touch of an ascending trendline. Failure to break lower sees room for a recovery until 1.2670 ahead of 1.27, while the clearance of 1.26–2610 bids triggers the initiation of a new cycle low towards 1.2580 as the next horizontal target.
Once again, the pair saw a vigorous rejection away from a key area of support circa 112.20–30. The correlations continue to provide clear selling signals as both the risk profile and the US vs JP yield spread keep deteriorating dramatically, suggesting a fair value of sub 110.00 in USD/JPY.
The absorption out of the daily chart is notable, but with sellers still drawing the line in the sand at the topside of the hourly range around 112.60, they remain the clear side in control. Selling on strength at key liquidity areas continues to be a strategy that should keep sellers ‘on the money’ as long as the divergence in valuations remain as clear as they are. If the follow-through doesn’t abate, 112.00 and 111.80 are the next objectives to aim for by sellers. Overall, the market still remains in gamma scalping mode judging by the impl vs hist vols, so be aware of fading moves at the edges.
We were well tipped way in advance, via the increase in Put premiums ahead of the FOMC, that interest to engage in topside sell-side action on the Aussie was on the rise. The daily shows a sizeable bearish price action, with the breakout of the key 7160 now a reality. The spurs of risk-off have dramatically compromised the outlook for the Aussie, as equities sell-off with earnest.
Drilling down into the hourly chart, the 100% fib projection target comes at 0.7192, a level that also aligns with the POC from the October balance area. If the momentum extends, the next key area to be targeted would be the year lows at 0.7150–0.7130, where support should be found, as it also aligns with the 100% projection target from the 7380–7220 breakout measure.
From today’s 25 delta risk reversals, we can observe the gradual reversion towards pricing Puts in the E6 contract more expensive than on the lead up to the FOMC, suggesting that the options perceive higher risks of the pair being offered after the supply imbalance see post the FOMC. Interestingly, the Sterling is not as bearish heading into the BoE, with the Puts premium reduced. The pricing of Puts in the Canadian Dollar has also come lower, in expectations of a potential pullback after the overextension in the charts. Not the case of the Aussie, with Puts priced at the same levels, which is never a positive sign. The most notable change in option premiums can be found in the ES contract, with the pricing of Puts going through the roof vs Calls, indicating the high degree of fear that exists. Lastly, we’ve seen a surprising reduction in the Call premium in the ZN contract (10-yr US bond).
* 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).
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