Posted on: 02 Sep, 2019
The market remains unphased by the structural issues in the US but instead, the currency keeps drawing major demand flows from the lack of pre-commitment by the Fed to ease to the extent the market is pricing, also assisted by the generalized risk-averse sentiment, but even a more compelling case is the ongoing shrinkage in US dollar liquidity...
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The US Dollar has been the undisputable leader of the Forex board in the last week of trading, in what became a rather eventful month of August, characterized by the escalation of the US-China trade way, with the latest announcements to hike tariffs actually coming into effect as I type. The market remains unphased by the structural issues in the US but instead, the currency keeps drawing major demand flows from the lack of pre-commitment by the Fed to ease to the extent the market is pricing, also assisted by the generalized risk-averse sentiment, but even a more compelling case is the ongoing shrinkage in US dollar liquidity as I will explain in today's report. The Japanese Yen and the Pound are the only two currencies that have been able to keep up with the bullish pace from the world's reserve currency. On the opposite side, the Euro opens a new month of trading below the psychological 1.10 at its lowest level since May 2017, with the high-beta AUD, CAD, NZD finding tepid demand.
The indices show the performance of a particular currency vs G8 FX. An educational article about how to build your own currency meter can be found in the Global Prime's Research section.
* The Information is gathered after scanning top publications including the FT, WSJ, Reuters, Bloomberg, ForexLive, Institutional Bank Research reports.
USD supply keeps shrinking: The US Treasury will remove liquidity from the commercial banking system this quarter by borrowing around $430 billion, which implies a form of quantitative tightening. The more scarcity of USD, the worse it is for risk conditions. Also, the cost of short-term borrowing goes up, also known as repo rate. Besides, if foreign financial institutions fail to meet the minimum regulatory requirements to hold USD-denominated assets, it can lead to banks forced to deleverage to obtain the extra USD. What's more, the reverse repo program between the Federal Reserve and foreign central banks has grown to over $300 billion, reducing the supply of USD further.
China's PMI in contraction for 4 months in a row: China’s official PMI for August came out on Saturday at 49.5 49.6 expected, which marks the fourth straight month of contraction, while the services read came at 53.8 vs 53.7 expected, which means the first marginal improvement for five months. Up next is the Caixin/Market privately surveyed PMIs this Monday, followed by services and composite on Wednesday.
China throws a lifeline to trade optimists: One of the reasons underpinning the recovery in risk has been the message China has intended to convey about the continuation of trade talks between the two sides despite the volatile behavior of US President Trump on tariffs. China foreign ministry stated last Friday that the US-China trade teams are maintaining effective communication. Markets held tight to the hopes that the big guns will return to the negotiating table in coming weeks even if the risk profile is starting to roll over as a new week starts after the combo of weak China PMI and no last-minute walk backs in the imposition of tariffs by either the US or China over the weekend.
The US and China go ahead with the tariffs: Over the weekend, Pres. Trump said that tariffs set to be enacted on Sunday against China will still go on as planned, which is obviously a negative for risk sentiment as there was some chatter that he may delay or back off at the last minute as part of his strategy to keep the markets well bid. A 15% duty will now apply to $110bn Chinese imports from footwear to technology gadgets, while the remaining $160bn of Chinese imports will see tariffs of 15% applicable from December 15, including tech devices such as laptops and mobile phones. The Chinese side has also retaliated by imposing an extra 10% in tariffs on $75bn of US goods, including American pork, beef, and chicken, which hits especially hard where Trump’s political base support is the strongest. Trump said on Friday that “we are going to win the fight" with China, adding that “the trade meeting in September is still on, it has not been canceled.”
The risk dynamics remain fragile as Sept gets underway: The RORO (risk-on, risk-off model) analysis does imply that the market profile is still faced with a troublesome outlook. None of the instruments most sensitive to risk sentiment, from the JPY index, the USD index, the long-dated fixed income, gold, USD/CNH, VIX and even equites (S&P 500) being rejected off a key resistance bodes well heading into Monday. The risk-weighted index, which combines the S&P 500 + US30Y also remains below its daily baseline (13-ema), which in practical terms it sends the message of risk aversion still the overarching theme.
The EUR fall draws Trump's attention: Trump tweeted about the sharp fall in the Euro from last Friday. “It is dropping against the Dollar "like crazy," giving them a big export and manufacturing advantage...and the Fed does NOTHING! Our Dollar is now the strongest in history. Sounds good, doesn't it? Except to those (manufacturers) that make a product for sale outside the U.S. We don't have a Tariff problem (we are reigning in bad and/or unfair players), we have a Fed problem. They don't have a clue! If the Fed would cut, we would have one of the biggest Stock Market increases in a long time. Badly run and weak companies are smartly blaming these small Tariffs instead of themselves for bad management...and who can really blame them for doing that? Excuses!”
The Italian political landscape remains uncertain: EUR fall to its lowest level since May 2017 below 1.10 comes as Italy’s new prospective coalition between Five-Star and the Democrats showed signs of public disagreement on the policy course agenda, even leading to Di Maio, leader of Five-Star, to imply new elections may be needed.
A misleading Canadian Q2 GDP: The Canadian Q2 GDP printed +3.7% vs +3.0% expected, which on the surface looks like a stellar report as it marked the best quarter since Q2 2017, with subcomponents such as exports growing at the fastest pace since 2014. However, the most notable forward-looking indicators disappointed, including business non-residential investment at -16.2%, which is the largest decline since 2016, while household consumption also fell to +0.5%, weakest since 2012. It was the type of report that should make the BoC concerned going forward and the market appears to agree by the refusal to accept the high levels the CAD printed post the GDP report.
The Univ Mich US consumer confidence plummets: The August final University of Michigan consumer sentiment came much lower than expected at 89.8 vs the calls for 92.3, which represents the lowest print since Oct 2016 and the largest 1-month decline since Dec 2012, which is a reason to get spooked as a macro investor. This follows a preliminary reading of 92.1 against a prior reading of 98.4. The rest of the subcomponents came on the weak side as well, including current conditions at 105.3 vs 107.4 prelim or expectations at 79.9 vs 82.3 prelim. The 1-year inflation stood at 2.7% vs 2.7% prelim. Paradoxically the consumer confidence data from the Conference Board recently released came at a solid level, which makes drawing conclusions a tough exercise. What’s clear is that Trump’s policies on trade keep increasing uncertainty and impact consumer spending negatively.
The EU inflation is nowhere to be found: The Eurozone August preliminary CPI came in line with expectations at +1.0%, while the yearly core CPI subcomponent stood at +0.9% vs +1.0% expected. The printing continues to argue for the ECB to flex its muscle with a rather bold easing policy to incentivize price pressures, even if the preponderance of evidence over the last decade suggests the effects have been rather futile.
China won't hesitate to intervene military in HK: The government-controlled China Daily Newspaper wrote that “while the SAR government has so far not felt the need to call on the garrison in HK, that does not mean it will not do so should the situation demand it. If the already ugly situation worsens, with the violence and unrest threatening to spiral out of control under the orchestration of secessionist-minded troublemakers, the armed forces stationed in the SAR will have no reason to sit on their hands."
Australia's housing permit data looks horrible: The latest data out Australia came very poorly, showing that the collapse in building permits for July continues to accelerate after a -9.7% m/m fall vs 0% change expected. On a yearly basis, permits are down -28.5%, which does not bode well for the revamp of the housing market.
ECB's Holzmann states an anti-dovish declaration: ECB's new member and Austrian National Bank Governor Robert Holzmann is starting to define his stance on monetary policy, noting that he is skeptical about further lowering interest rates. The policymaker said that “I will probably voice a somewhat more critical stance concerning suggestions about a future deepening of the monetary footprint.”
The EUR index has found a downside resolution away from its accumulation period, in what represents one of the largest one-day declines this year. The close outside the 1x ATR from the baseline (13-d ema) is a warning sign that further follow-through is largely unattractive at this levels, so I wouldn’t be surprised to see a retest of the previous support-turned-resistance first. However, the push lower on Friday has certainly opened the doors to a more bearish context heading into this week. As a caveat to any over-exposure to play short EUR, be reminded that the RWI line (risk-weighted index) in orange remains highly elevated, which could easily lead to EUR bids arising from playing the divergence between RWI and EUR.
The GBP index continues to trade bullish above its baseline even if it lacks much impetus to move in either direction for the last few days. On the upside, the latest appreciation in the Cable was rejected at a critical level of resistance, while the downside finds two critical areas of support in the form of a dynamic one (baseline) currently tested, ahead of key horizontal support level clearly visible in the chart (in red line). Remember, we are about to enter a highly volatile period when trading the GBP as the UK parliament returns from recess and policy-makers keep fighting tooth and nail to avoid the suspension of parliament by next week.
The USD index is undeniably bullish, trading well above its baseline at a level that unless you fall under the category of the fast money type to get in and out of the market for short scalps, the location where it trades does not offer much appeal for the nimble traders out there. That said, the trend can last much longer than I can anticipate and long USD has definitely proven to pay handsome returns, especially when bought on retracement back to the baseline rather than after 5 days of straight rises as is the case at the moment (that’s the point to take home today). The outlook is bullish but it trades at a rather expensive price level. Still, the chatter of ongoing shrinkage in USD liquidity is likely to keep the bid in place as the lay of the land stands.
The CAD index has found support on the way down at a level that had accurately acted as resistance during most of August. Judging by the outlook in the risk profile (orange line), a follow-through continuation to the upside faces real challenges but technicals remain bullish, which makes me overall supportive of longs but major caution must be exercised. The main reason is that when the RWI and the CAD show this extreme divergence, high-beta currencies tend to perform quite poorly, which sooner or later leads to sell the CAD at great cheap prices.
The AUD index has re-taken the baseline on the daily but notice the buy-side participation is dropping as per the aggregate tick volume, alongside the fact that the risk-weighted index is so low it makes it inherently very dangerous to be long AUDs at these levels. Technically, there is some room for the index to appreciate until the marked red line (resistance), which should represent a fantastic location to capitalize on anticipated AUD weakness based on the premise that the high-beta currency remains too expensive vs the risk profile.
The NZD index undeniably put on the greatest trend to trade during the month of August and judging by the technical outlook, the dynamics are not yet changing. The trend is your friend, which is why playing longs in NZD for any duration above a few hours for strategic calps has proven to be a nearly suicidal consideration. The market psyche has morphed into selling any possible chance it’s had a mild rebound and I see no reason why it can’t last another week.
The JPY index has opened the new week with an upside gap as risk deteriorates and with such a lofty risk-off-weighted index (the higher the more risk aversion), it looks rather logical to expect a market that will remain highly interested to bid the Yen. The market structure is definitely very constructive, with the index not having lost its baseline for more than a month. Note, the baseline has been an excellent technical bedrock for buyers to re-group during the trend.
The CHF index has been detaching itself from its strong correlation against the risk profile. The follow-through selling keeps its course on the back of the bearish outside day last Thursday, with the increase in sell-side tick volume suggesting more depreciation might be in store. The more it declines, however, the more value it exists to engage in value trades as sooner or later, it’s to be expected that the CHF may catch up with the risk-weighted line. Note, trading the CHF and understanding its correlation dynamics can be quite tricky at times due to the fact that the SNB continues to be intervening in the market by selling its domestic currency in an ad-hoc basis.
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