US Equity Bounce Within ‘Risk-Off’ Context

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.

Quick Take

The ‘risk-off’ regime we’ve gradually transition into since mid last week still remains in place, with some minor signs of abating via equities not yet providing enough technical evidence to shift the focus back to bid risk. Unless the equity bounce is backed by yield curves or a significantly weaker DXY, I wouldn’t read too much into the late US equity rally as to single-handedly be able to revert the fortunes of what’s an otherwise still cloudy outlook.

In today’s write-up, I argue in favor of a potential continuation of the JPY strength against selected currencies such as the EUR or the AUD. Similarly, amid this environment, commodities such as Oil should go through a hard time. If global equities resume the rollover, it will take us back into micro-macro ‘risk-off’ flows back in alignment, likely to support USD, JPY, Gold.

Narrative In Financial Markets

  • US politics the main driver in the last US session on Friday, as Trump wall talks breakdown, which is raising the prospects of another government shutdown.
  • The US administration is mulling 3 different options for EU car tariffs: 10% rate, 25% rate, specific customs duties. The news didn’t bode well for European stocks.
  • Canadian jobs showed another blockbuster reading with 66.8k new jobs. One fears seasonality factors are playing a major factor in the back-to-back outlier prints in Dec, Jan.
  • After news broke out that Trump and Xi won’t meet before the March 1st China-US tariff deadline, we learned over the weekend that the next trade talks set for Feb 14–15.
  • The massive rise in iron ore prices continues, currently at a 4 ½ year high. One can argue that the surge in the commodity + late rise in the SP500 helped lift the Aussie off lows.
  • San Francisco Fed President Mary Daly raises the prospects of a potential idea in which the Fed uses QE as a more regular policy tool in the foreseeable future if pre-conditions in place.
  • The Forex market continues to be characterized by the rude health in USD demand flows, in what is widely perceived as the temporary winner of a very ‘ugly contest’.
  • Barnier says EU won’t reopen the Brexit divorce deal while UK PM May is said to be seeking legally binding changes to the withdrawal agreement in meeting with Ireland’s PM.
  • Not only Italy is in a technical recession to start the year, but Istat (Italian Statistics Bureau) warned that it foresees a pronounced slowdown in economic data. Italy is the elephant in the room not many are talking about after the budget deal with the EU but watch this space.

Potential Drivers — Economic Calendar

China is back from holidays, that’s why it will be critical to follow very closely the performance in the Yuan as a continuous barometer of the trade negotiations alongside the Shanghai Composite/CS300.

The overarching key story ruling markets continues to undoubtedly be the China-US trade negotiations. The rhetoric has turned progressively negative since last week, with the cancelation of the Trump-Xi meeting the last straw to see an increased interest to go ‘cash’ and play more defensive.

That’s why this week’s trade talks will be, as has been the case, highly critical to monitor even if the complexities involved suggest these are talks that are most likely going to go down to the wire, hence no breakthroughs are eyed short-term.

In the UK, we get growth and manufacturing data as a sideshow to Brexit.

Source: Forexfactory

RORO Model: Risk-On Risk-Off Conditions

From a microflows standpoint, the late rebound in the S&P 500, even if it has turned the slope of the 25-HMA upwards, does not carry enough credence for one to latch on and conclude that constructive ‘risk-on’ conditions are set to extend much further. The main reason is predicated on the basis that the rebound occurs in the context of a newly found bearish macrostructure in the S&P 500 as per the downward slope in the 125-HMA (5-DMA).

Additionally, the rest of the risk assets monitored as part of the model are far from sending us the right signals to support risk trades. We are faced with a backdrop in which the DXY shows little signs of slowing down its bull trend, while the US 30-year bond yield continues to move downhill.

Even more worrisome, Gold has decoupled from its negative correlation with the DXY by printing gains on Friday even as the USD rose. Whenever this happens, the market may be anticipating trouble ahead by diversifying into gold as a shelter to protect against a wave of deleveraging risk.

Overall, the pre-conditions are far from ideal to support a sustainable ‘risk-on’ environment. The combination of movements can be understood, from a micro perspective, as ‘weak risk-off’ in nature, which is wrapped within a broader context of a ‘true risk-off’ market profile.

Yield Curve: Outlook For Growth, Inflation & Policies

The environment continues to be dominated by deteriorating bull flattener dynamics, which should add to the notion that the environment is far from constructive to lean on risky currencies.

With the exception of the Canadian Dollar, which saw its yield curve improve a tad, the rest of G6 FX are all caught up in a downward spiral of anticipatory lower growth and weak inflation.

What this means is that this environment, if anything, worsens the outlook for the market to recover back its mojo and I’d expect the JPY and the USD to fare quite well against beta currencies.

Wonder what’s the yield curve in a bond? It’s really critical to understand what the market is pricing in terms of Central Bank policies going forward. Learn the basics in this article.

Chart Insights: Technicals & Intermarket Analysis

EUR/JPY: Case To Sell On Strength

In light of the negative risk backdrop expected, one would expect the JPY to be well positioned to capitalize on the weakest currencies. On my radar, I can think of two in particular (EUR, AUD). The former looks particularly attractive from a technical standpoint, as the current rebound is faced with a plethora of converging bearish technicals such as the rest of a broken resistance-turned-support circa 124.35–40, a downward sloppy 25-HMA, coupled with a tap into last Friday’s POC. The trade would be negated should the market structure of lower lows gets violated by a breakout of the 124.70–75 level, in which case, a re-assessment of the conditions will be required.

EUR/USD: Sellers In Absolute Control, 1.13 Next Target

Buyers continue suffocated by the selling pressure ignited ever since Feb 4th. While in the last early stages of the bear rally the trend developed in a non — volatile orderly manner, the last 2 trading days we’ve seen buying flows coming in with more impetus. Regardless, attempts to regain control above the previously highlighted critical 1.1350–60 have failed with each corrective leg up being weaker in magnitude (35p followed by 28p). With the 1.1325 low now taken out, the next focal point is likely to be 1.13 round number. Any rebounds will face pressure technical pressure emanating from momentum traders given the slope of the 25-HMA. Similarly, a descending trendline off Feb 4th high alongside Feb 7, 8 POCs overhead suggests further clusters of offers ahead that may limit any rally and still make it corrective in nature with the market eyeing 1.13, where significant buying pressure is a real possibility judging by the major divergence with the yield spread. Also note, the mentioned psychological level is a perfectly symmetrical target as a 100% measured move from 1.1512–1.1405.

GBP/USD: DXY Strength May Cap Upside, Brexit Dependent

Technically speaking, there is still a case to be made for the Sterling to find buying interest off 1.2925–30 horizontal support. The latest BoE-induced spike breaking above the previous structure high at 1.2970–75 does offer some offer some technical credence that implies demand is re-emerging. Buyers need to hold this critical line at 1.2925–30 from which the rate should be lifted up towards the 1.2970–75 to keep re-calibrating the technical into a more neutral stance. However, be reminded that any rebound would still be trading into negative flows originating from correlated instruments such as the DXY or the UK-US yield spread, both supporting further declines.

USD/JPY: Resolution Away From Range Needed

The market is currently experiencing its most prolonged low vol phase in 2019. The lines of battle have been clearly defined on both sides, with the weekly horizontal resistance in red having acted as an excellent anchor point to define the midpoint of the current phase of consolidation. By analyzing the behaviour in USD/JPY’s most correlated assets, the latest rise in the DXY + SP500 does support the buying on dips mentality for now, while the major divergence with depressed US yields does also suggest that any retest of 110.00 and beyond should find increasing sell-side interest in light of such macro divergence with what’s arguably been, according to the correlation coefficient in the 3rd window (in green), the most correlated asset in recent times. At this point, there are only 3 key areas to be involved from an hourly perspective (110.00–110.10, 109.85–90, 109.55–65).

AUD/USD: Mild Recovery Amid Depressed Yield Spread

The first tentative technical cracks of the bearish trend are starting to be observed, as buy-side flows have resulted in the breakout of a short-term descending trendline. A retest of the area of resistance at 0.7115–20 would allow for the market to transition into a range from 0.7060–65 up to 0.7115–25. As the correlations stand, the weakness in the Australian-US bond yield spread, alongside the bullish momentum in the US Dollar, should keep supply pockets fairly strong as the pair correct higher. The recovery in the S&P 500 in the last 24h has arguably assisted the rebound off lows, but with domestic factors (yield spread) playing a more important role for the Aussie, and as the correlation coefficients suggest, it’s the yield spread and the DXY+Yuan we must pay special attention to.

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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. The Ultimate Guide To Identify Areas Of High Interest In Any Market
  • 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
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