Yen Rules As US-China Trade Deal At Risk

Today's explosion in volatility in the Forex market right off the gates comes after an incendiary tweet by US President Trump, taking the whole market by surprise at a time when based on the price action across various asset classes since the beginning of the year, a trade deal between the US and China had been fully discounted.

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.

Quick Take

Today's explosion in volatility in the Forex market right off the gates comes after an incendiary tweet by US President Trump, taking the whole market by surprise at a time when based on the price action across various asset classes since the beginning of the year, a trade deal between the US and China had been fully discounted. The 180-degree turn by Trump, now formally threatening China to hike tariffs to 25% on $200bn by this very Friday, it gives a market with highly committed capital into equities sufficient reasons for a macro re-think, which is currently being manifested by a serious unwinding of positions in the S&P 500 futures, the Shanghai Composite and the rest of equity indexes. The rampant buying on the Japanese Yen or the aggressive selloffs in the Aussie reflects the new state of concerns about the outlook for global growth if China doesn't buy into Trump's threats. The fate of the market hinges on whether or nor China confirms the rumors circulating around about the cancelation of this week's trade talks by Liu He and his team of representatives. Be prepared for a tumultuous week as each unfolding scenario will have ramifications with one common theme to be expected, a volatility pickup.

Narratives In Financial Markets

  • Major gaps as the market caught off guard by Trump's tweets on China over the weekend, threatening to hike tariffs, reportedly frustrated at the slow pace of progress. This is an event fully priced in, so any setback will have significant ramifications as not expected by the market.
  • Selling commodity-linked FX and buying the Yen right off the gates as 'true risk off' dominates has been the main hand played by the markets, with the ‘risk off’ swing finding a new leg lower as reports emerge China may be considering to cancel this week’s trade talk trip.
  • If a US-China trade deal is put on hold for the time being, it equates to a lower US trade deficit, which we’ve already seen evidence of it in the last report. This translates into less USD in circulation globally, which tends to see a higher USD, further boosted by ‘risk off’ flows.
  • The RMB has seen a fairly punchy move down in early Asia, reaching its cheapest level since January this year in the largest 1-day move since Aug ‘15, as CNH outflows dominate. China will need a significantly weaker Yuan to offset the increase in tariffs amid slower global trade.
  • The low vol FX regime, where carry USD longs as a strategy have thrived, is at risk as the stable Yuan trade unwinds. This means a change of dynamics with wilder intraday movements in FX as the USD finds, via ‘risk off’ and not carry, a new source of strength.
  • Traders are now waiting for news on how the Chinese Central Bank will react to the threats by US President Trump. The longer it takes for the PBOC to communicate its strategy, the more uncertainty is to reign. As a precursor that they won’t budge for now, the PBOC has set the USD/CNY reference rate at 6.7344, way below USD/CNH current rate of 6.80.
  • Then we have the perky GBP and its relentless rise as the UK press reports that Labour MPs will not back a Brexit deal without a second referendum. Besides, UK PM May, according to the UK Telegraph, has held discussions behind closed doors over a possible 3-way second referendum. This week, PM May is about to outline plans for a comprehensive but temporary customs arrangement with the EU, with the timeline deadline until the next general election.
  • Last Friday’s US NFP, which looks like a distant prospect given the latest headlines, reinforced the notion that the US labor market remains very tight even if wage pressure still underwhelms. The headline number came very strong nearly at 263k while the jobless rate made a new low of 3.6%. The increase in monthly salaries stood at 0.2%.

Recent Economic Indicators & Events Ahead

Source: Forexfactory

RORO (Risk On, Risk Off Conditions)

Unless China comes forward to calm the markets with some type of bona fide intention to completely ignore the latest threats by US President Trump, the environment is set to remain hectic. A wildly lower Yuan and Aussie as a proxy to play the Yuan short trade in international markets has been the play most aggressively manifested. On the contrary, long the Japanese Yen and bonds is paying off handsomely, especially the former as the Yen index depicts. Goes without saying, there is currently a major unwind in the US equity market, where the S&P 500 futures are down by over 2%.

The picture is even uglier when it comes to the Chinese stocks, selling by as much as 4% at the open of the Shanghai Comp. The VIX is also set to torpedo towards its highest levels in months. Remember, the next VIX short futures outstanding has recently overtaken the VIX Feb ‘18 highs. It is a perilous terrain to be trading FX with the same risk dynamics. Be aware that the volatility looks set to to pick up further this week, contingent to China’s response, so be prepared to expand your usual stop loss placements while allow to be more generous with targets as these are the type of volatile environments that tend to promote outsized movements that may eventuate in higher risks to reward.

Latest Key Developments In FX (Technicals, Fundamentals, Intermarket)

EUR/USD: Not Budged By ‘True Risk Off’ As Structure Improves

The pair is a sea of relative tranquility when cross-checked against the volatility seen elsewhere in FX. The exchange rate has managed to contain its move in a rather limited range, which has been confirmed after the Bollinger band turned flat. Whenever you see a market with the external Bollinger band going from directional to flat, that’s telling us the market has entered a consolidation phase. A break above the 1.12-1205 resistance area, which happens to be the 100% proj target of last Friday’s US NFP extension would expose the next level of resistance at 1.1220-25, ahead of the 1.1235 target. On the downside, breaking 1.1175-80 with acceptance below suggests 1.1165-60 as the next stepping stone in the form of Friday’s POC, ahead of 1.1145-50. Note, the breakout of the descending trendline in the exchange rate, coupled with a double distribution up where the POC got trapped behind, tends to be a recipe for sellers to experience further setbacks, especially judging by how impulsive the shift in flows was on the upside break from last Friday.

GBP/USD: Supply Ensues After Double Rejection of 100% Target

The exchange rate, which has been on an absolute tear as of late, met one of its possible 100% proj targets to the pip on the back of last Friday’s US NFP, coupled with positive Brexit headlines. A more ambitious upside target that is still pending to be reached would be 1.3220, a 1:1 full extension through the 1.2985 - 1.31 breakout extension. At the open of markets in Asia, the pair appears to be losing some of its strong bullish momentum after the double rejection of the 100% proj target and the increased pockets of demand in the USD we are seeing as the US-China trade deal is in jeopardy. The first area of engagement by buyers should be on an approach of the 1.31 liquidity-rich area, followed by 1.3075-80, which happens to be the 50% fib retrac of Friday’s US NFP-led rally. Even if the GBP setback extends all the way to 1.3040-45, which I see as the next critical support, that won’t damage the bullish structure in the price of the exchange rate. For that, A break and hold sub 1.3020 (Friday’s POC) is necessary, which tells you a lot about how insane the rise in the Sterling has been, judging of course, by recent standards or much more compressed volatility in the Sterling.

USD/JPY: Sold With Earnest On Trump Tweets

The weekend tariff spat by Trump against China has reinvigorated the demand towards the Yen as the risk profile turns aggressively ‘true risk off’ as the value lines on the 2nd and 3rd windows demonstrate. Not only the S&P 500 and bonds, especially the former, are imploding, but the USD has failed to draw much demand interest so far, hence fueling the downside momentum. The inability of buyers to fill out today’s ample gap in Asia before a 2nd leg was found is a testament of how fluid the situation has become. Despite the ADR limit for the day has been hit, the relevance of today’s news that a US-China trade deal might not happen after all has the potential to see far greater vol, which is why the next sellers’ target at 110.00-110.10 still stands as a realistic prospect today. Technically, the major barrier to break on the way up can be found at 110.70-75, which happens to be the violated 200% proj target measured from the range breakout last Friday. As the market dynamics stand, and even with the moves so overstretched, the downside is certainly the path of least resistance as long as the risk profile, which can be monitored through the formula in the 2nd window, remains bearish.

AUD/USD: Acceptance Sub 0.70 On Trump’s Incendiary Tweets

Asia flows were quick to adjust the pricing of the Aussie back sub 0.70 as fears of a major setback on the US-China trade talks took effect. The Aussie is hyper sensitive to any fundamental news emerging out of China, therefore tends to pretty much be pegged to the fluctuations in the Chinese Yuan in many occasions as the best way to internationally express one’s view on China. Today’s selloff in the Yuan, sharpest fall since Aug ‘15, has been a major burden leading to the unfilled wide gap at the open. The moment that news broke out of the Chinese mulling not to attend this week’s trade talks in Washington, a 2nd leg transpired, revisiting the proj 50% target, which must be utilized as our first level of reference to find a level of activeness by market makers given the ample 0.7025-0.6985 extension used to measure the first symmetrical target. With the value line, which accounts for the Chinese Yuan + DXY, deeply on the red, it’s hard to expect strong flows making it back into the Australian Dollar unless China tries to calm the waters. The next 100% proj target can be found at 0.6945-50, level where the next cluster of bids is expected to be concentrated, as market makers, contrarian traders and profit takers step in, conditioned to vol moves.

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 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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