Posted on: 14 Dec, 2018
Don’t we feel all as having a Brexit overdose? For once, and without setting precedence, I am especially enthusiastic to hear what Mr. Draghi has to say.
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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 Ivan on Twitter.
Don’t we feel all as having a Brexit overdose? For once, and without setting precedence, I am especially enthusiastic to hear what Mr. Draghi has to say. Will his speech leaves us a sense that the underlying weakness in the Eurozone through H2 is transitory or will Draghi exhibit a greater degree of concern, implying that the slowdown in the Eurozone is more durable?
Another focal point for today’s meeting includes the discussions about QE reinvestments, with expectations for more clarity as bond maturities come due. The forward guidance on the reinvestment period, the average maturity and the composition of the portfolio are the key aspects to keep an eye.
The perky Pound found plenty of buying interest, which feels counter-intuitive, although judging by the overextension of the sell-off, that was a risk to face. The fact that UK PM May survived the leadership challenge by a decent margin (201 vs 117) feels like still not enough.
Viraj Patel, FX & Global Macro Strategist at ING notes, that “the opposition may think 117 is big enough to topple the government in Commons & see a general election”, thus “the risks is that GBP continues to drift lower especially if UK opposition parties now push for a Commons no confidence.”
Also, as part of today’s bonus insights, I update readers with yesterday’s trade idea, when I endorsed playing a long position on CAD/JPY based on the risk profile recovery I was expecting. Filled in Asia.
As per today’s tweet shout out, it goes to arguably one of the top macro traders helping me to stay updated day in and day out on the latest developments in the market. @fxmacro is a must-follow.
The risk-weighted index found a fresh leg up, breaking the previous high, assisted by the rise in both the S&P 500 and US rates, while the US Dollar trades on the backfoot. The current profile, based on the latest movements in financial markets, is characterized by classic ‘risk-on’ conditions.
If we were to take cues from cross asset classes, the outlook for risk heading into Thursday continues to be vindicated by the new structure high in the RWI, the uptick in junk bonds, even if prudence and be on high vigilance is still warranted as the VIX remains very elevated at 21.5.
By taking a look at the yield curves, the true ‘risk on’ profile is supported by the steepening of the US yield curve (10y-2y), which communicates a diminutive improved outlook for growth. An analogous move has eventuated in the Japanese yield curve, giving us a promising jump start in Asia.
Also, the moment the ECB is out with its latest policy statement, expect risk-sensitive assets to re-calibrate their valuations based, in part, to the ripple effects of the stance by the ECB.
As a reminder, the latest changes in options positioning have played a key role in defining my view over the potential recovery in risk. My constructive outlook was aided by the increasingly aggressive buy-ups of IM calls in both the S&P 500 and the US 30-yr bond yields, as documented yesterday.
In terms of valuations, Wed’s bullish price action came amid an alienation of a bet returning towards the 5-yr German vs US yield spread, with another positive emanating off the 10-yr German vs Italian yield spread, making a fresh cycle high. Even the 10-yr German vs French yield saw a bid coming back, allowing to remove some pressure off the European-shared currency.
On the daily, my endorsement to play longs on weakness remains unabated. Notice the range is getting narrower, with the closes by 5pm NY time in the last 2 weeks waxing and waning between 1.13 and 1.14. What this means is that a period of compression tends to follow one of expansion.
We need to always ask ourselves the right question. If we were to bet for a breakout in either direction, judging by the clues obtained via options and yield spreads, which direction is more likely? The answer to me, as a close observant of intermarket relationships and options activity. I want to be a buyer of Euros at these markdown prices owed to the major disparity in German vs US yield spreads, but also on the clues I am getting via where option players are buying up downside protection, with out of the money puts finding a higher level of accumulation in the 1.13–1350 vicinity.
On the hourly chart, I’ve marked the key levels of liquidity as usual. Note, some initial technical cracks are taking place after the clear violation of the descending trendline off the Dec 10 high. Wednesday’s recovery in the Euro found a cluster of offer circa the most recent POC around 1.1380 as depicted by a rectangle in my hourly chart. For the next 24h, subject to a shocker by ECB’s Draghi, I will concentrate my efforts in engaging in buy-side action off liquidity levels. Any levels sub 1.13 would present, in my opinion, a stellar opportunity to load Euro longs.
The Sterling valuation continues to favor the upside based on the UK vs US 5-yr yield spread, while also assisted by the recent downtick in the USD. However, in the wider context, there are still more ‘cons’ than ‘pros’ to be a buyer in this market. The political disarray in the UK remains a major source of concern for markets, and while UK PM May has won the confidence vote, fears are growing that she is really trapped in a ‘cul the sac’ Brexit road with no easy way out. Not enough votes in the UK parliament to get her Brexit deal through and no willingness by the EU to make the substantial tweaks to the compromise, so that the Irish backstop sticking point is resolved. I feel that part of the recovery in the Pound on Wed was partly due to an excess of bad news priced out, although on the grand scheme of things, the breakout of support at 1.2680–27, has set in motion targets as low as 1.2140.
On the daily chart, we can clearly see the Sterling edging close into its previous support turned resistance at 1.2660 up to 1.27, which should cap the gains for now. On the hourly, the buy-side interest has been very significant, to the extent that a new bullish cycle has now been validated. What this means is that those with an interest to buy the Sterling on dips have now a more constructive technical backdrop to lean on, although still in disagreement with higher time frames.
Nothing has changed in terms of valuations for this market, which are unambiguously bearish & predicated on the depressed levels of risk and the US vs JP yield spread. However, short-term, it is the bulls that have taken clear control after the massive bullish outside day on Monday. I am still betting of a market that lacks any sort of conviction to break out of its 112.30 -114.00 range. The FOMC meeting next week could change all that depending on its narrative.
On the hourly chart, the bullish run has so far produced 2 legs up, which makes me think that we might still be missing a third push higher to retest the 113.50 high ahead of the next topside targets at 113.75 and 114.00, which is where I’d expect the pair to start trading topish with true value to engage in sell-side campaign if traders can align the macro value gap with the micro ones. As long as buyers can keep the price above the 112.90, the structure of the market favors the long-side.
With the offshore yuan regaining its strength and the Hang Seng index supported by the recovery in risk appetite, the outlook for the Aussie appears to have improved. What this means is that the topside of its 1-week range at 0.7235–40 may continue to be tested, with the price action still building higher highs and higher lows intraday. I’ve drawn a rectangle across the midpoint of the range, which often tends to help us as a precursor to understand what side of the range may breakout first. This theory is predicated on the basis that if a particular side takes control of the midpoint of the range through various rejections, it will communicate an interest to test the top/bottom side next. Bottom line, the Aussie is trapped in a range, with risks building up for a possible upside breakout.
An update on yesterday’s CADJPY long idea: I was filled long o/n, in lien with a risk reprieve expected, stark contrast in recent fundamentals (JP GDP 👎, CA jobs 👍), Oil anchored by $50.00, plus steeping of US & JP yield curves offering positive lead for risk in Asia too. Find the insights below.
If you want to be satiated with all the latest macro news, especially as they relate to forex, here is a must follow contact for you. He goes by the handle @fxmacro and he is someone who just happens to be constantly in the flow of the moment, keeping us all up to date with the latest developments.
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