RBA No Longer Asleep At The Wheel? GBP Awakens To Brexit Reality
Ivan Delgado | Feb 05, 2019 11:58PM ET
Narrative In Financial Markets
- Disappointing UK data (Services PMI misses by 1 bp) alongside no clarity in the Brexit front, keep the Sterling offered outright throughout Tuesday. UK PM Theresa May is scheduled to meet EC President Juncker on Thursday with very low expectations for a real breakthrough. Fears are on the rise that an election or UK PM May resignation may be on the horizon as the Brexit deadline approaches with the UK in need for more time that they simply don’t have.
- US equities keep extending gains for the 5th day in a row, with the Nasdaq Composite the outperformer, accumulating near to 20% gains since the bottom in late December. In an even stronger fashion, European equities found strong demand, with earnings backing the moves.
- USD navigates Tuesday’s seas with surprising firmness despite the notable decline in US government bond yields and a poor US Non-Manuf ISM print (56.7 vs 57.1), in which new export orders was the main laggard amid a global slowdown in trade activity.
- The AUD was the main mover on Tuesday, alongside the GBP, after the RBA kept its rates unchanged at 1.5% in what appears to be a rather complacent approach given the mounting evidence of headwinds into the real economy. Tuesday’s Aus retail sales (-0.4%) was yet again another disastrous read not boding well for the Australian economy. The spike in the Aussie came mainly in response to a squeeze in short positions after the RBA failed to blink. UPDATE: RBA’s Lowe has changed that today.
- Headlines around the US-China trade negotiations have logically slowed down as China celebrates its golden week (new year). But there is no time to waste for the US, and a US Treasury report in Congress states that it intends to ‘hold China accountable’ for unfair, market-distorting trade practices, which sounds like a dampener on building positive vibes.
- As an anecdotal development without any influence in financial markets given that there were no compromising headlines on monetary policies transcending, Fed’s chairman Powell and Vice Chair Clarida has an informal dinner with US President Trump on Monday night.
- According to a report via Reuters, some ECB members are hesitant to alter the rate guidance even if the Eurozone economic data has been appalling in fear of impacting the term of the next ECB President, due to be appointed later in the year. It may help to partially explain why the ECB has been so slow to revise its downgraded outlook to the economy.
- In today’s much-awaited RBA’s Lowe speech, the Governor has finally admitted that the next rate move is evenly balanced, which is a shift in rhetoric from the ‘next move likely up’. The Australian Dollar was marked down aggressively after the headline.
- US President Trump addressed Congress in the State of the Union. Some of the key points included addressing illegal immigration, infrastructure spending with no signs that he will resort to an emergency funding by government decree to address the issue of border security and start the partial building of a wall, as it would set a dangerous precedent.
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RORO Model: Risk-On Risk-Off Conditions
In terms of microflows, the strength in the DXY and US bonds (lower yields) is a concern that should keep risk-on flows capped. This is what the model classifies as ‘weak risk-off’, which for now is partly offset by the rude health in equities. As per the macrostructures, the disconnect between the DXY and US30Y is a rare occurrence, especially as US equities keep rising. In this context, any minor shakeout in equities rises the risk of upsetting the constructive risk profile. Whenever we face ‘weak risk-off’ conditions, it’s important to be reminded that this is a scenario that would be partly negated or fully overridden if the rise in equities is rapid and elongated in nature. Moreover, some currencies may detach if fulfilling other individual criteria, as seen in the case of the Australian Dollar, where the wait-and-see stance by the RBA has driven positive flows into the Aussie.
Yield Curve: Outlook For Growth, Inflation & Policies
United States: Bond traders have reverted back into bull flattening dynamics. When that’s the case, the market perceives slower economic growth with no risk for an overshoot in inflation. In this environment, unless risk-off returns with a vengeance, the USD upside should remain capped against other fundamentally strong currencies. The problem is that none seem to fit this latter category. As one can observe in the table, all macro yield curves are in either bull steepeners or flatteners, which communicates a broad-based deteriorating outlook for global economies.
Europe: There has been a little tick-up in the short-dated bonds, accumulating 2 days of a bear flattener, which suggests no recovery in growth is expected with less of a risk for the ECB to make any bold move in monetary policy in the short-term. The report that some ECB members refuse to alter their views on rate guidance could be a factor supporting the yield curve for now. Note, as in the case of the rest of countries, the macro yield curve outlook is poor, no growth/inflation eyed.
Australia: At a micro level, the Australian bond government yield has become a tad more attractive in response to a perpetually neutral RBA monetary policy meeting. The complacency shown has, in turn, resulted in bond traders pricing out, at the margin, rate cuts in the country. However, the nascent run-up in yields micro-wise faces a negative macro yield curve backdrop, where bond traders have cemented a more pessimistic view in the Aussie economy of decelerating economic growth and low inflation. It implies the Aussie still lacks a solid fundamental backup on its own right.
United Kingdom: The clear underperformer on Tuesday was the Sterling. By looking at the drop in bond yields, with a resumption of bull flattening tendencies, bond traders are growing more skeptical about the outlook of Brexit and the ramifications for the overall economy. The recent rise in the Sterling is also an environment that keeps inflation prospects very low. It is in these phases when the micro and the macro yield curve align that a currency is most vulnerable to sell-offs.
Canada: The view towards the Canadian economy via bond yield valuations is following in locksteps the dynamics in the US. The absence of economic data in Canada in recent days makes this relationship to obtain cues via US fixed income strengthen even further. Not the ideal scenario when a country’s bond yield curve is on a bull steepener (micro) and bull flattener (macro).
New Zealand: As in the case of Canada-US, another twin relationship is Australia-New Zealand. In the last 24h, the latter has benefited marginally from the muted RBA decision by piggybacking the moves in Aussie bond yields. This correlation should end when NZ publishes its employment numbers on Thursday morning NZ time as bond traders will finally have a fresh driver to manifest their views on the New Zealand economy. From a macro view, New Zealand is the country most punished by an expectation of easier monetary policies as the long-held bull flattener reflects.
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 .
Options — 25 Delta RR & Vols
The most notable change in the last 24h is the increase in the price of owning puts in the Sterling, now at the highest spread vs calls this year. Also notice, implied volatility is set to increase in the Pound (yellow line), which makes the risk of further downside a real prospect.
* The 25-delta risk reversal is the result of calculating the vol of the 25 delta call and discount the vol of the 25 delta put. … A positive risk reversal (call premiums rise vs puts) tends to be a bullish signal to expect higher spot prices according to option traders and vice versa if put premiums increase vs calls.
Source: http://cmegroup.quikstrike.net (The RR settles are ready ~1am UK).
Chart Insights: Technicals & Intermarket Analysis
EUR/USD Reaches 50% Fibonacci Retracement
The momentum in the pair is undoubtedly to the downside as depicted by the 5-DMA, but by analyzing the daily chart, there are a few factors that traders should be alerted by. First off, the fall in the Euro comes in the context of higher German vs US bond yield spreads, which means other elements aside from capital flows are driving the pair lower. The transition into lower levels has now landed at a key converging technical level circa 1.14, which aligns with the 50% fib retracement.
Besides, a 100% target projection from 1.1475 (cutting through the wicks) to 1.1435 breakout point gives us a period of potential cycle maturity in the green box highlighted. In the short-term, also notice that the 25-HMA applied to the German-US bond yield spread is also turning its slope upwards. By assessing the volume tick patterns, notice the decreasing volume in the last 3 days? That’s a potential sign of exhaustion in a market that is offering enough credence not to rule out a turnaround, especially if the market finds acceptance above Tuesday’s POC at 1.1420.
GBP/USD In Free-Fall Mode, DXY Strength + Brexit Weight
The Sterling sell-off move, from a daily perspective, looks rather overextended after 4 consecutive days of losses and 6 out of 7. We should go back to late October ’18 to find a GBP so unfavored. Nonetheless, with the crack of 1.30 now a reality, the 5-DMA slope keeping the rhythm bearish, the slope in both the DXY (green line) and US-UK bond yield spread (blue line), and the POC trapped above 1.30, there is enough evidence to think that this bearish run may have further to go should Brexit headlines play in favor.
On the hourly chart, the 100% projection target from the 1.3155–1.3005 measurement has been reached, and as it is often the case when price breaks through, it’s now acting as intraday resistance. Note, there is a high risk that this market exhibits some type of bounce before a potential bearish resumption as the magnitude of the move is very elongated. Any retracement is likely to face the maximum amount of sell-side pressure via offer clusters at 1.30, 1.3025 ahead of 1.3050–55.
USD/JPY: Boosted by Equities/DXY, Resistance at 110.00 Tough To Crack
While the pair has been picking up momentum, the relatively easier gains have been made. As I stated back on Monday, last Friday’s commanding bull bar carried enough momentum to see the 110.00 level tested, but unless US yields can back up the move, it’s hard to see equities and the DXY alone doing all the heavy lifting necessary to eat through a major cluster of offers from 110.00 up to 110.30 (horizontal resistance). The current dynamics can be understood as a period of consolidation between 109.75–80 and 110.00–05.
A resolution in either direction may determine the next bias especially if the breakout occurs with the 25-HMA slope of the DXY and US30Y in favor. At the moment, US yields are rolling over as the green line exhibits, which poses a risk of topside head-fakes, even more so if we see any weakness in equities, with no evidence, and that’s precisely what’s helping to keep the USD/JPY relatively bid in a context of lower US yields. Remove the lifeline via rising equities, and a DXY appreciation alone won’t cut it for the bulls.
AUD/USD: Sold Hard As RBA Hints Prospects of Lower Rates
The technical dynamics in the Aussie have clearly shifted in the last 1h or so after the RBA Governor finally caved in by acknowledging that under the current economic conditions, the interest rate outlook is more evenly balanced, which is a downgrade from his more previous sanguine view. The sell-off has set in motion a bearish momentum move that could easily extend into the next support area circa 0.7145–50 in coming sessions ahead of a 100% projection target at 0.7125–30.
What may still keep the emergence of bids at certain intervals in the rampant run in equities, but beware that this is a fundamental-led move that on its own right, even better if supported via DXY strength as seen, can inflict further damage to the Aussie. Any revisit of 0.72 up to 0.7230 offers an opportunity to engage in sell-side action at what one could argue to be the most pristine levels.
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.
- 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.
- 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.
- 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.
- 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.
- 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.
- 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.
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