Trade Conflicts Morph Into Currency War

The markets are engulfed by a sense of fear and uncertainty about a new low Yuan regime as the focus shifts from a trade-centric conflict into a trade war. The ramifications in the currency market, amid a vivid risk-averse environment, has been for capital flows to stick with the usual suspects (Yen, Swissy, Gold, Bitcoin, Bonds) as equities sell-off in a disorderly manner.

The Daily Edge is authored by Ivan Delgado, Market Insights Commentator 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 in order to determine daily biases and assist one’s decisions on a regular basis. Feel free to follow Ivan on Twitter & Youtube. You can also subscribe to the mailing list to receive Ivan’s Daily wrap.

Quick Take

The first week of August 2019 will mark the time when China finally opted to draw a line in the sand by telling US President Trump, enough is enough. That's the key takeaway by not intervening in the USD/CNH but instead letting market forces determine the exchange rate, which as of the close of NY, sit around 7.10. The US Treasury has been fast to label China a currency manipulator, which essentially puts the nail in the coffin to any glimmer of hopes for trade negotiations to continue. The markets are obviously engulfed by a sense of fear and uncertainty about this new environment as the focus shifts from a trade-centric conflict into a trade war. The ramifications in the currency market, amid a vivid risk-averse environment, has been for capital flows to stick with the usual suspects (Yen, Swissy, Gold, Bitcoin, Bonds) as equities sell-off in a disorderly manner. 

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.

Narratives In Financial Markets

* The Information is gathered after scanning top publications including the FT, WSJ, Reuters, Bloomberg, ForexLive, Institutional Bank Research reports.

PBOC spooks the market by letting Yuan depreciate: The story of the day is the tumbling of the Chinese Yuan, breaking above the 7.00 mark in USD/CNH terms (close near 7.10) as the full-blown trade war swiftly morph into a currency war. The fact that the PBOC has not intervened to keep the exchange rate below the psychological level but instead allowing the rate to be market-determined is a clear statement of intent that they are looking to weaponize their exchange rate to offset the increasing number of Chinese products being taxed as part of the trade war.

USD/CNH above 7.00 is an inflection point: It really looks like the breakout and close way past the 7.00 level in USD/CNH is a major inflection point and markets are reacting accordingly. The Chinese central bank has been largely on the sidelines doing its job to keep the yuan stable in order to facilitate trade negotiations aimed at projecting a message of goodwill. But with the trade war escalating, its lack of intervention must be interpreted as a clear message that the US has gone too far. Interestingly, iIf China had the intent to use the currency to completely offset the full impact of the US tariffs, it implies further depreciation until levels closer to 7.40, according to ANZ Strategists.

A weaker Yuan as a double-edged sword: But allowing the yuan to depreciate, while it acts as a mechanism to offset trade tariffs, it can also backfire as the action could be quite costly for China’s financial conditions. The disorderly depreciation of the Yuan has led to a major sell-off in China’s equity market, which also heightens the risk of acceleration of capital outflows and putting pressure on the economy.

Trump calls China's action a major violation: While the PBOC has just simply let the market take over without the normal interventions being conducted, US President Trump has responded such ‘inaction’ by calling it a ‘major violation’. Trump’s tweet read as follows: “China dropped the price of their currency to an almost a historic low. It's called "currency manipulation." Are you listening to Federal Reserve? This is a major violation…” What's ironic from reading Trump's comments is that it was precisely the PBOC intervention that kept the Yuan strong. 

China set to retaliate via hold of US Agric purchases: As part of China’s set of measures to retaliate against the US after last week’s tariff hike announcement by Trump, China is now mulling to place tariffs on US agricultural products purchased after August 3, according to the state media. This is news that was confirmed by the China Global Times editor Hu Xijin via Twitter, who stated that the exemption of tariffs for US farmers will be lifted alongside the pause to buying US farm goods such as soybeans.

Pay attention what they do, not what they say: PBOC governor, Yi Gang, made official comments via a state media channel by stating that the current yuan exchange rate is at an appropriate level, adding that China won't engage in competitive currency devaluation, even if the actions demonstrate otherwise. Yi Gang expanded his contradictory statement by noting that the PBOC “will not use the yuan as a tool to cope with external disturbances, such as trade tensions”, and that “fluctuations in the yuan exchange rate are driven by the market.” Some disconnect with reality indeed as the PBOC has been defending the psychological level of 7.00 whenever its been on its best interest.

US Treasury labels China 'currency manipulator': It gets worse, as US Treasury Secretary Mnuchin, via an official Treasury statement, has labeled China as a currency manipulator, causing further mayhem in the markets. The highlights of the statement included a reference to engage with the IMF to eliminate unfair competitive advantage or that China's actions are a violation of their G20 commitments. This decision by the US Treasury really puts the nail in the coffin for hopes of trade talks resuming. Rather than restoring calm to the markets, it throws more fuel to the fire for uncertainty to build.

True 'risk-off' markets w/ usual suspects benefiting: The trading dynamics continue to be characterized as “true risk-off” with the usual suspects (Yen, Swissy, Gold, Bonds), even Bitcoin, benefiting from the run to safety as the USD tumbles. One potential circuit breaker for today would be the setting of a lower USD/CNH fix rate, PBOC intervention in the USD/CNH or the addition of liquidity via HK.

Probability of a 50bp rate cut by the Fed on the rise: As the markets take a hit and financial conditions tighten in the US, one of the reasons for the US Dollar not to be as appealing as an investment vehicle today is the fact that the Fedwatch tool is now assigning a 35% chance of a 50bp rate cut in Sept, with a 25bp cut fully priced in.

All the while US & China economic data disappoint: If the market turmoil caused by the trade war was not sufficient, the July US ISM non-manufacturing came at a disappointing 53.7 vs 55.5 expected, which marks the lowest level since August 2016 as momentum continues to be lost from the peaks above 60. On the Chinese side, its latest China Caixin Services PMI also underwhelmed at 51.6 vs 52 expected.

Former Fed bosses send a message to Trump: Former Fed Chairs at the Fed are calling for independence at the Central Bank. In an article signed by Paul Volcker, Alan Greenspan, Ben Bernanke, and Janet Yellen, they take aim to send a clear message to Trump to stop bashing the Fed and don’t get his nose into its affairs.

NZ Treasury warns of tough times ahead: The New Zealand Monthly Economic Indicators, released by the NZ Treasury, sent a warning to the market by noting that the downside risk to near-term GDP growth forecasts have increased. The more pessimistic outlook was attributed to weak domestic business confidence due to ongoing trade uncertainty which is weighing on global business activity too. On the bright side, they mentioned household confidence remains resilient, supporting the consumption outlook.

But NZ jobs tells us a completely different story: The latest employment report released Tuesday morning local time caught the market by surprise as the Q2 unemployment rate dropped to 3.9% 4.3% expected. We don’t get to see these types of beats in the jobless rate that often, which has been reflected in a major spike in the Kiwi, since the rest of jobs-related data was also supportive, including a 0.8% employment change q/q vs 0.3% expected or the steady participation rate at 70.4% (inline). Even the average hourly earnings, including private wages, jumped to 0.8% vs 0.5% expected. 

Recent Economic Indicators & Events Ahead

Source: Forexfactory

A Dive Into The Charts

At the center of every day’s analysis, we must understand the overall performance of the currency indices when cross-checked against a basket of the most heavily traded currencies. With the market engulfed by huge risk aversion, the likes of the Yen or the Swissy continue to do well, with the latter accelerating its gains dramatically in a move that starts to look overdone. Also note, the Yen index has reached its 100% proj target, so I’d expect the currency to find a cap in its relentless appreciation right around these levels. The Euro index, against conventional belief, has broken into a new cycle high, as the implied probability of further and deeper rate cuts by the Fed in Sept keeps rising. That’s what might be interpreted as a key driver for the lower USD valuation, however, be aware that the USD index is now testing a key resistance-turned-support, which makes it an appealing technical buy if one’s system triggers the signal to enter. What is important to note is that the USD is retesting a level where a flurry of buy-side activity may be seen, with the ‘risk-off’ context still justifying the play. The commodity currencies (AUD, CAD) were smashed down once again, while the NZD is now reverting its downward momentum after a stellar NZ jobs report. Last but not least, amid the crossfire of trade/currency war headlines, the GBP index has been flying largely off the radar, but its weakness on Brexit uncertainty remains dominant in what’s become the steadiest trend.

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.

First off, let’s start looking at the outlook for USD/CNH, without a doubt the pair that dominates the market thematic at present. From a technical standpoint, the huge spike from the 6.96 breakout point all the way to hit the 100% projection target hints the move is overdone and some type of pullback is needed to bring stability back to the markets. Fundamentally, as one would have expected, the setting of the USD/CNH by the PBOC today at 6.9683 has induced the anticipated unwinding of CNH shorts, with the announcement of PBOC issuing bills in Hong Kong in an attempt to help stabilize the Yuan also a contributing factor.

With the Yuan fluctuations what’s going to determine the variations in the ‘risk-on’ & ‘risk-off’ dynamics, it’s no surprise that some assets in high demand amid the escalation of the trade war are experiencing some minor corrections such as the price of Bitcoin. However, the resolution of the digital asset above a descending trendline after carving out a double bottom makes the current bullish dynamics an unfinished business phase until the next target at 13.2k is reached.

Another asset class finding plenty of interest as capital flows seek out protection is gold. I’ve been interested to narrate a bullish story in this market since the formation of the bullish outside day last Thursday, which to me implied a major shift in order flow and a market ripe to extend into new highs with the clear target to be achieved next at 1,500.00, which would coincide with, you guessed it, another 100% projection target.

Another market that I find extremely appealing to see a rebound today is the USD/JPY. Not only the USD index has met support and the Yen index has reached its 100% proj target, but in the pair USD/JPY, we’ve hit the 105.50 mid-round level, which is confluent with the 100% proj. So far, as one could have anticipated by tapping into the magic of the 100% proj symmetries, where market makers are going to form clusters of orders, we’ve indeed seen a rebound. As long as the Yuan depreciation is contained around present levels, the trade today is to find levels to engage in buy-side action.

I won’t get tired of emphasizing the power of the 100% proj because it really is that precise at helping us understand when turns in the market occur as traders take profits in anticipation that heavy limit orders by market makers will cause a shift in order flow at points in the chart where no longer exists a perception that the currency pair is rated at a fair price. Judge by yourself, as today it’s the case of the EUR/CHF, AUD/USD (other Aussie pairs too). Since last week, I also pointed at the potential reversal in the making due to the confluence that existed in CHF/JPY; in this latter, fast forward to present levels and check where the rate has been sent to…

Alongside the conviction for gold to resume its uptrend, I’ve also reflected on the probability that if Crude Oil were to make a correction to retest its breakout point, which it did on the back of last Friday’s US NFP, that the market was poised to at least retest the lows before a re-assessment, and that’s precisely what we’ve seen.

Similarly, on the S&P 500, after last Thursday’s reversal in order flow, which was manifested in an inverse bearish pin bar re-taking a level of support, I posted the following: “The upper shadow with a close below support as volume increases dramatically is a recipe to see further follow-through supply in the index. Besides, the bearish price action on Thursday has broken the bullish structure by closing below the previous swing low on July 17th.” Today, the index is more than 150 points lower on the back of that price action clue post-Trump’s new tariffs to China.


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. 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 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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