Nov 19: What’s The Outlook For Risk Sentiment?

Indisputably, one primary market driver includes the growing optimism that orbits around some sort of China/US trade deal as we head into the G20 summit in Argentina early December.

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.

Fundamentals: Break down of market drivers + key releases

Indisputably, one primary market driver includes the growing optimism that orbits around some sort of China/US trade deal as we head into the G20 summit in Argentina early December. I personally still believe that this improved tone in risk is largely manipulated by US President Trump talking up hopes of a positive outcome with the intent to see a recovery in local equity valuations after the recent volatile moves seen.

Another major market driver includes the Brexit conundrum. UK PM May remains in shaky grounds, and while a draft agreement on Brexit has been hashed out, there remain many uncertainties ahead, including a potential leadership threat. A minefield of risk headlines around Brexit should continue to translate in high volatility when trading the Sterling. The chances of a Brexit deal approved through the parliament are very thin, which leaves UK PM May with 3 choices. A hard Brexit no deal, a new referendum or general elections.

The Fed is turning a bit more cautious on global growth based on last week’s outlook report. This surprisingly new narrative, even if far from threatening the immediate path of hiking rates, is a reminder that heading into 2019, rate hikes will come at a higher price as liquidity keeps draining out of the system amid slower growth around the globe, especially if US and China continue at odds when it comes to finding a potential trade agreement. Not to mention the risk of the fiscal stimulus fading and the twin deficits the US will be faced with (balance and fiscal budget).

The calendar is vacant for the next 24h of business. Find below a snapshot of the economic data highlights from the last 24h.

Risk model: Recovery in risk hinges on equity performance

As we can clearly observe in the yellow box below, the dynamics in risk conditions have seen a marked improvement in the last 24h as reflected by the black area (risk-weighted index), which comprises the SP500 + US 30-year yield – DXY.

This improvement in risk has been driven by a recovery in US equities coupled with a lower USD and US yields. This puts us in a USD weakness environment short term (both from an order flow as well as from a structural view).

This means that the cues to gauge the next wave in risk sentiment will continue to be determined by the performance in equities, while the USD underperformance remains.

Let’s now start to dissect the risk-weighted index part by part. As I’ve been warning for a few days now, if we are counting on the equities to keep doing the heavy lifting to sustain risk, we are far from being out of the woods yet based on the S&P 500 hourly structure.

The Head & Shoulder pattern is still very much a possible play, as price approaches a critical resistance at 2,765.00, which would be the right shoulder.

The context for the pattern to play out I’d say is decent. Let’s not forget that the latest up leg in early November ended in an exhaustion off 2,816.00 daily resistance, from where an impulsive move down with solid velocity and rich in magnitude took place.

That makes the sell on rallies strategy a viable one based on the order flow seen and the agreement of structure.

Note, if we find acceptance above 2,765.00/70.00 in the S&P 500, this scenario would then be invalidated and we might be setting up for a re-test of the previous high of 2,816.00.

There is some hope that we see a recovery in US yields if only based on the anticipation of where we yield trade at (key daily support).

However, we’ve seen the breakout of the previous range with acceptance below on the hourly, which has validated a fresh down-cycle as order flow keeps building fresh US bond positions (yield sold).

For the overall risk recovery to be further underpinned by the performance of US yields, the 30-year should at least see a resolution above the descending trendline around 3.35%.

With regards to the USD, here we need to be mindful of two forces. On one hand, the hourly chart has seen control re-taken by sellers, creating a new cycle low, although I am expecting lower levels to attract significant buy-side interest potentially around 96.10, which is the 100% projection target. This scenario would be negated if we break the descending trendline shown n the chart below.

What this means is that very short term, there might be further downside in the hourly move seen before the current cycle matures. If that’s the case, the projected move lower on Monday should continue to support risk bids.

The road ahead for risk to find new legs up will be a technical challenge based on the structure of the S&P 500 (case negated above 2,765.00/70.00).

If instead, we count on a USD-centric move to keep risk afloat, be mindful that we might not be at the optimal juncture just yet if basing this premise on the latest sell-off in the DXY, not until we see 96.10 projection target tested.

Looking at the US yields, a lift from current levels is definitely an option to consider given the daily support found.

However, for risk to remain sustained even on a lower S&P 500, US yields will need to still battle through above a descending trendline and intraday resistance while assisted from more downside in DXY.

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