The Daily Edge—Risk-off Even As China Truce Details Emerge

In the FX space, movements were largely contained within familiar ranges, with the British Pound putting up a fight even if no technical resolutions were noted so far. The Aussie succumbed after a terrible Aus Q3 GDP and ended up the worst performer.

The Daily Digest 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 for the next 24h of trading in order to assist one’s decisions on a regular basis. Follow me on twitter.

📊RATES BY NY CLOSE📊

Note: Markets in the US were closed to honor the memory of former US President Bush senior. As one can immediately tell, the board continues to be dominated by a sea of red.

⚡EXPRESS VERSION⚡

In the FX space, movements were largely contained within familiar ranges, with the British Pound putting up a fight even if no technical resolutions were noted so far. The Aussie succumbed after a terrible Aus Q3 GDP and ended up the worst performer.

A dovish BoC led to a significant decline in the Loonie and the Canadian bond yields as the expectations of further rate hikes were dialed down. The deterioration in risk assets continues, and at the open of the ES futures market on Globex, a major sell-off forced the Chicago Mercantile Exchange to implement circuit breakers. This occurrence fits the storyline of risk-off.

Today’s major focus shifts towards the OPEC meeting. I’ve noted option traders turning more bullish via the aggressive buying of ITM Calls + OTM Puts as protection. There are some tentative signs that some type of agreement will be sealed to reduce the oil output.

🔥MACRO DRIVERS🔥

  • After much deliberation and days of silence, China Ministry of Commerce finally confirmed that US-China talks at G20 were successful. The narrative, therefore, shifts to more committal, with China pledging to push forward trade negotiations with the US in 90 days. This is a positive development given that this is the first time more details were published. The official statement from China MOFCOM can be found in this link.
  • US President Trump tweeted about China in order to portray an image of confidence following the recent trade truce agreed in Argentina. Trump wrote “"very strong signals being sent by China once they returned home from their long trip, including stops, from Argentina. Not to sound naive or anything, but I believe President Xi meant every word of what he said at our long and hopefully historic meeting. ALL subjects discussed!”
  • Just be aware that US President Trump will always be talking his own agenda, and as we all know, he tries to emphasize certain matters to such an extent that he tends to lose touch between desire vs reality. Proof of that is a report by the Washington Post earlier this week, highlighting the irritation of China as Trump kept boasting a victorious narrative on trade, even if China denies to have even agreed to certain concessions Trump claims.
  • Today’s major focus is going to be at the OPEC meeting. There has been plenty of talk about a cut in Oil supply to address the current supply glut amid lower global demand. It appears as though the consensus number thrown at puts the headline number of 1 million/barrels cut as the minimum threshold to expect and therefore any numbers above may act as a temporary circuit breaker to keep Oil sustained. Nigeria and Lybia are reportedly agreeing to participate in the cuts, which is a positive early sign. Even Oman’s Oil Minister has come forward suggesting that all OPEC+ members are on board to implement production cuts, potentially starting from January and to last for 6 months.
  • The latest report coming from Italy suggest that the government is set to send a revised budget proposal to the EU some time next week, hoping to close in the differences. The German vs Italian yield spreads continue to climb higher, which bodes well for the Euro.
  • If there wasn’t enough confusion in how the Brexit process will play out, we learned on Wednesday, via the UK government full legal advice, that any backstop could endure indefinitely. The document reveals that any Brexit deal can’t force the European Union to end the Irish border or that the review mechanism does not provide a unilateral way to get out of the backstop, hence the risk that the UK could be stuck in negotiations. This latest snippet of information is the opposite of what UK PM May needs to even have the most remote of the chances to win over Parliament’s trust on the Brexit deal agreed.
  • Even if it feels way too premature, according to a report by Reuters, ECB policymakers are currently debating scenarios for a gradual stimulus withdrawal next year. Note, all the references to such action hinges on the ability of key European economies such as Germany, France, Italy or Spain to reinvigorate its growth projections after the notable slowdown in activity during the 2nd half of this year. Besides, any considerations to rate hikes continue to be referred to as only occurring ‘through the summer of 2019.’

📶 FUNDAMENTALS📶


  • The Australian Q3 GDP saw a disastrous reading of 0.3% vs 0.6% exp. This puts the yearly growth at 2.8%, which is still above the historical trend, but it unequivocally makes the market much more leery over the prospects of a more hawkish RBA anytime soon. The drop in the saving rates by households amid the fall in housing prices and tighter lending standards or the poor consumption measures should all be sources of concern as it indicates an economy that is losing significant momentum. Business investment is another department where the growth has faltered as major gas projects finalize.
  • The Bank of Canada kept interest rates unchanged at 1.75% but this time, the forward guidance came with a clear dovish tilt, which makes a rate hike in January less likely. The Central Bank’s central focus appears to be shifting towards the weaker growth in Q4, partly due to the sharp losses in Oil prices, while adding that there may be more room for non-inflationary growth, so essentially they see risks of higher prices subdued. As a result, the Canadian Dollar and bond yields both fell drastically. Overall, it looks as though the BoC is setting the stage for a temporary pause in its tightening cycle.
  • The Fed’s Beige Book, which tends to be a sideshow for the markets, but nonetheless a decent barometer of the current economic conditions, was published. The main highlights included concerns over unusual seasonal patterns as firms try to import an increasing number of goods out of China before additional tariffs on China take effect. Besides, all twelve Fed branches reported modest economic growth from mid-Oct through Nov. In terms of the labour market, indications continue to be overwhelmingly positive. In terms of pricing, it will be interesting how it plays out. Will suppliers eat up the increases after the tariffs are implemented or will they be passed on to consumers? It remains to be seen. On housing demand, branches in NY, Dallas and Cleveland highlighted a slowdown.
  • Looking ahead, the Australian retail sales and trade balance is due shortly. But make no mistake, the OPEC meetings are going to take absolute center stage today, which will not only influence the price of Oil, but the ripple effects will be felt across other asset classes such as the Canadian Dollar, US bonds as a re-price of future inflation expectations is factored in, which will obviously have a bearing in the valuation of equities. Remember, the drastic declines in Oil have placed key actors in the OPEC cartel, such as the Saudis, who rely heavily on the sustainability of the price, in a difficult situation. Some type of deal with other members is almost baked in the cake, the amount is what’s going to be absolutely critical. Expect the ranges to be discussed between 1m and 1.5m/barrels.
  • We get a raft of data out of the US, but none as relevant as the ISM Non-Manufacturing PMI. If it serves as a reference, Monday’s ISM Manuf came comfortably above expectations. The consensus for today is for a slowdown from 60.3 to 59.2. In the last 3 months, the indicators have beaten the projected numbers by at least 1 point. By going as far back as early 2017, it’s also notable to see the clear uptrend. The reality is that the bar to match up last months reading above 60.00 has been set very high, that’s why the USD may face some slight pressure heading into the event amid the negative expectations.
  • Out of Canada, at 13.30 GMT, BOC Governor Poloz is due to speak about the economic outlook, risks in Canada's financial system, and the December interest rate decision at the Chartered Financial Analyst Society Breakfast Seminar, in Toronto. Audience questions expected. At the same time, the Canadian trade balance will be released.

👎RISK MODEL👎

My prop risk-weighted index continues to deteriorate further, currently trading at the lowest levels since early July after the latest sell-off in the S&P 500 just cracked through the August lows, which as a reminder, happened to be when the China-US trade war was at its highest.

The impulsiveness of the move down in equities, via the S&P 500, bodes ill for risk sentiment right off the bat here in Asia, with futures testing the 2,660.00 region. Tuesday’s sell-off, when the market opened for the last time, came accompanied by the highest volume day since Nov 21, which tends to be a precursor of more pain ahead as it suggest a committed sell-side campaign in underway, with a clear target of 2,630 in sight now.

Shifting gears, the technicals in the US 30-yr bond yield communicate that we are likely to find some respite short-term, as the yield meets a major weekly support area (in red). On the way down, the yield absorbed with surprising ease an area of daily support (in blue) in a fall that carried much higher volume than its normal 20-day average. What this means is that the sell-side action is definitely finding plenty of commitment in a move that has meat on the bone.

The picture in the DXY is less clear, with very messy price action as of late, which indicates most of the cues to make judgement calls on risk will be obtained via the royal battle we are seeing between bonds and equities. The disconnect in Gold as a function of USD performance, now acting as a safe-haven vehicle once again, should be a major red flag that the risk-off environment, while potentially getting some risk-on intraday swings, continues to be structurally conducive to act defensively by sitting more in cash. At the bare minimum, it suggest a market that is turning less constructive towards the US Dollar as the Fed slows down rate hike exp.

Bottom line, the risk conditions from an order flow and structural perspective, suggest that we remain in dangerous territory. Even if the US 30y bond yield recovers, the speed and volume of the declines in the S&P 500 make me wary of any risk-on flows finding sufficient support.

🌟FOREX MAJORS🌟

EUR/USD: Buy on weakness favored as valuation point north

The pair has been stuck in a 100+ pips range ever since the spike in demand off Nov 28 lows. Market makers and range traders have been dominating for now, with 1.13 to the downside being the line drawn in the sand by value buyers. I say ‘value’ because at present, any Euros being exchanged nearby the 1.13 are definitely offered at a discount based on where the German vs US yield spread and the Italian premium trade at. The decoupling is too obvious to ignore, which makes buying on weakness a very viable strategy. Ever since the origin of the demand candle on Nov 28, the price has been achieving higher levels, while any attempts to transact offers that meet the 1.1315/20 periphery are rejected in no time. Overall, this is a market that has written on the wall, buy it at discount prices for now.

GBP/USD: Playing with fire around the 1.27 area

As usual, this is a very tricky market to trade as we approach next week’s Brexit vote in the UK parliament. The sentiment surrounding the Sterling remains overwhelmingly negative as the market factors in a rejection of the Brexit pre-agreement by UK PM with the EU. I am expecting that any downside risks will steem as a result of Sterling’s demerits vs USD-centric strength. Neither the UK vs US yield spread on the long-side of the curve nor the DXY index offer enough justification to support a sustainable breakout unless is a GBP-induced move. The hourly chart remains extremely choppy, with 1.2680 - 1.2840 covering the near term eventualities for now. The implied volatility in the Sterling continues to highlight volatility ahead. Be reminded that intraday trading in the GBP pairs remains largely dominated by algo trading.

USD/JPY: Bearish tendencies set to extend

Selling on strength should be the main play in this market unless the technical picture is negated. For now, the technicals, with an active downcycle on the hourly, are leading the way. If we think of valuations, the flows should also be JPY positive judging by the depressed risk-off profile this week, coupled with new cycle lows in the US vs Japanese yield spreads. The area highlighted during Dec 5th report at 113.20 found enough of a supply imbalance to revert the short term recovery, with 113.00 (round number and POC) now being targeted ahead of the 112.70 hourly liquidity that lies underneath. It really feels as this is a market that is prone to be sold on strength at every chance one has of engaging of decisions points. If this first attempt fails, watch for 113.40/50 as another major resistance area to engage.

AUD/USD: No end in sight to the long liquidation

The Aussie has seen a substantial removal of liquidity off its trend highs as buyers pulled the plug out of its trend-trading mentality as the rate adjusts to worsened fundamentals following a dismal Australian GDP in Q3. The daily cycle remains bullish, and I must say that the volume on the way down has been far from impressive, partly due to the close on markets in NY. The next level where a cluster of bids is expected can be found at the 0.7250, where the origin of a strong demand candle meets with an ascending trendline in the daily (major confluence). The Aussie may continue to flounder near term, vindicated by risk-off and weaker fundamentals, but technically wise, and as we know, the Aussie is a very technical-oriented pair to trade, any level below the 0.7250 area does offer some pristine levels to potentially be a buyer. Just be aware that the sentiment is very negative at present time.

📅OPTIONS MARKET📅

EUR/USD: The Dec contract, about to expire by the end of the week, shows an interesting development as over 477 ITM Puts were bought on Tuesday, Dec 4th. Similarly, almost 2k OTM Puts were pulled out of the market. When combined together, it suggests that the outlook for the Euro this week is far from promising, which could easily be attributed to the increase in risk-off conditions the market was hit by during Tuesday. The increase in ITM Puts communicates players with an interest for a directional move prior to the contract’s expiration, while the reduction in OTM Puts equates to a decrease in interest to tap into options as a vehicle to protect one’s long views in the pair near term. Nonetheless, by scoping out the info presented in the chart, it’s still very notable to see the Put vs Call ratio in volume terms at 2.14, which means there is still a lot of interest to purchase cheap protection via OTM Puts.

OIL: Ahead of the crucial OPEC meeting, options traders are starting to show their hands. Based on the data collected on Dec 4th, Tuesday, the latest activity has taken a bullish turn as reflected by the increase in ITM Calls by over 800 contracts, which complements with greater commitment to buy OTM Puts to the tune of 3,418 new contracts. The highest concentration of OTM Puts remains around the $50.00 mark, while OTM Calls sees the most activity at $55.00.

US10Y: A lot of profit taking in the US bond market in the 10-year, which is no wonder considering the overstretched movement we saw. The decision to remove close In The Money (ITM) Calls by almost 75k contracts could be a precursor that the downside may be limited near term. Those removing their exposure must have a similar belief or else they’d still be in the trend. This action marries really well my views above that long-dated US rates may have reached an exhaustion climatic stage after the overextension seen this week.

Remember, if implied vol is below historical vol, the market tends to seek equilibrium by being long vega (volatility) via the buying of options, which is when gamma scalping is most present to keep positions delta neutral by covering one’s risk. On the contrary, if implied vol is above historical vol, we are faced with a market with unlimited risks given the increased activity to sell options. Other than GBP, which runs a far greater implied vol than any other currency, one should not be oblivious to the downside risks in EUR/JPY based on the current ratio above 2%, which means a market significantly short vega (volatility), as such, a follow through acceleration move through 127.70/80 may be on the cards amid the absence of gamma scalping.

📈BONUS CHARTS: WHAT ARE YOU MISSING? 📈

Stephen Spratt, Global Rates Strategist at Bloomberg, via a tweet, posted the sudden turn in fortunes for the rates outlook in Aussie land, noting that the “RBA OIS curve has now inverted”. The likelihood of a rate cut is now greater than a rate rise in 2019.

Did you know that our prop EM FX index has recently regained the 200-day MA. Throw into the mix the bearish structural breakout in the USD/CNY, and one can probably start making sense why JP Morgan, in yesterday’s research report, was constructive on EM FX. Read below.

One of the anticipated culprits that may lead to an eventual slowdown of the US economic activity is housing. In the chart below, Joe Weisenthal, Co-host of 'What'd You Miss?' on Bloomberg TV, shows some shocking stats about the state of affairs in the housing and real estate front, based on the deviation between actual data and expectations.

🔍INTELLIGENCE GATHERING🔍

Morgan Stanley stands by its perma USD bear calls. In its latest research report, the bank reveals that it has added a new long play in EUR/USD for an ultimate target of 1.18. As I argued above, Morgan Stanley sees the downside resolution in USD/CNY as a potential catalyst to unravel further weakness in the US Dollar. EUR shorts in money markets may soon run to the exits, the bank believes. Find an extract of Morgan Stanley’s research below:

Sacha Tihanyi, Deputy Head of Emerging Markets Strategy at TD Securities, put together his thought on what could go wrong for China in 2019. Risks of China under-delivering on growth expectations? The massive 40%+ decline in its stock market this year is a reminiscence of a country in trouble, hard to argue against that bit of evidence. The analyst argues that next year’s underperformance may lead to greater monetary and fiscal support for the economy, exacerbating China’s debt burden and as a result, may see the Chinese Yuan under downside pressure as capital exits. Read TD Securities research extract below:

🏆QUOTE OF THE DAY🏆

“History provides a crucial insight regarding market crises: they are inevitable, painful and ultimately surmountable.” Shelby M.C. Davis

📌 IMPORTANT FOOTNOTES📌

  • Risk model: The fact that financial markets have become so intertwined and dynamic makes it essential to stay constantly in tune with market conditions and adapt to new environments. This prop model will assist you to gauge the context that you are trading so that you can significantly reduce the downside risks. To understand the principles applied in the assessment of this model, refer to the tutorial How to Unpack Risk Sentiment Profiles
  • Cycles: Markets evolve in cycles followed by a period of distribution and/or accumulation. The weekly cycles are highlighted in red, blue refers to the daily, while the black lines represent the hourly cycles. To understand the principles applied in the assessment of cycles, refer to the tutorial How To Read Market Structures In Forex
  • POC: It refers to the point of control. It represents the areas of most interest by trading volume and should act as walls of bids/offers that may result in price reversals. The volume profile analysis tracks trading activity over a specified time period at specified price levels. The study reveals the constant evolution of the market auction process. If you wish to find out more about the importance of the POC, refer to the tutorial How to Read Volume Profile Structures
  • Tick Volume: Price updates activity provides great insights into the actual buy or sell-side commitment to be engaged into a specific directional movement. Studies validate that price updates (tick volume) are highly correlated to actual traded volume, with the correlation being very high, when looking at hourly data. If you wish to find out more about the importance tick volume, refer to the tutorial on Why Is Tick Volume Important To Monitor?
  • Horizontal Support/Resistance: Unlike levels of dynamic support or resistance or more subjective measurements such as fibonacci retracements, pivot points, trendlines, or other forms of reactive areas, the horizontal lines of support and resistance are universal concepts used by the majority of market participants. It, therefore, makes the areas the most widely followed and relevant to monitor.
  • Trendlines: Besides the horizontal lines, trendlines are helpful as a visual representation of the trend. The trendlines are drawn respecting a series of rules that determine the validation of a new cycle being created. Therefore, these trendline drawn in the chart hinge to a certain interpretation of market structures.
  • Correlations: Each forex pair has a series of highly correlated assets to assess valuations. This type of study is called inter-market analysis and it involves scoping out anomalies in the ever-evolving global interconnectivity between equities, bonds, currencies, and commodities. If you would like to understand more about this concept, refer to the tutorial How Divergence In Correlated Assets Can Help You Add An Edge.
  • Fundamentals: It's important to highlight that the daily market outlook provided in this report is subject to the impact of the fundamental news. Any unexpected news may cause the price to behave erratically in the short term.
  • Projection Targets: The usefulness of the 100% projection resides in the symmetry and harmonic relationships of market cycles. By drawing a 100% projection, you can anticipate the area in the chart where some type of pause and potential reversals in price is likely to occur, due to 1. The side in control of the cycle takes profits 2. Counter-trend positions are added by contrarian players 3. These are price points where limit orders are set by market-makers. You can find out more by reading the tutorial on The Magical 100% Fibonacci Projection
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