What can we expect from AUD/USD?
- Could be at the start of a new Elliott Wave pattern to the upside but a break of .7400 is needed to confirm
- .7160 is an important support level if it breaks this could suggest trend continuation
- RSI has broken lower watch out for a hold above 50
On the market profile chart, the area between .7157 and .7018 looks very congested. We have since auctioned higher and ranged between .7157 and .7393. If we saw a bearish NFP result we could revert to the mean value area of .7254 or possibly higher. If the market is net bearish this could be the area where a lower high is formed. In a bullish view, only a break of .7293 would confirm a wave break higher.
Across the currency spectrum, and not just against the USD, we have seen a weakness in the AUD in the past week or so, with domestic matters weighing on the currency, in particular, this week. The RBA meeting threw up few surprises in keep rates unchanged and maintained the balance of economic pros and cons within its statement. In essence, the RBA still sees the next rate move as up, though as has been the case for some time now, it is a matter of timing and widening differentials with US rates have largely dictated losses in the spot rate. In the past month or so, however, AUD – along with the NZD – has recouped some ground against the greenback, though this has been more a function of its oversold status and in the time it has been achieved.
Hitting highs close to 0.7400, AUD/USD resistance has been largely based on the global factors surrounding the threats to global trade. As US actions against China have threatened demand for Australian raw materials, so the longer term negative bias is set to contain the upside. There was been some periodic mismatch in the sensitivity to data – for example, the relief from the near term truce between the major economic powerhouses over the G20 weekend, though as above, domestic matters are now weighing on the AUD, with this week’s Q3 growth coming in lower than expected at 0.3%. Trade data was also lower than forecasts, though both cases argue for continued expansion – perhaps not as much as expected, though enough to battle through tough times in the current climate. We have also seen commodity prices picking up and finding some resilience despite a stronger USD, so this should suggest a level of underlying demand as the world ‘ticks over’.
Australia may be some way off raising rates from current levels, but at this stage, some of the alarmist calls for a rate cut seem out of place in our view.
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USD/JPY has recently broken lower following the recent sell-off in equities markets. There are some key signals to wait for before the downside move can be confirmed. Obviously, we have had the shooting star candle a couple of days ago but the trendline break will be significant. Elsewhere, the price has made its first lower high and a break of 112.30 would make a lower low.
The weekly RSI trendline has broken to the downside. If we see a confirmation of the move lower, look out for the 111.78 support level. The chart below then shows lower down the 50% Fib confluencing with some key previous support and resistance levels.
Zoomed in hourly chart of the trendline: as you can see if the trendline was on your radar it offered significant support.
There was great anticipation ahead of Fed chair Powells speech in NY last night, where there were concerns that he may have attempted a tone down in the rate path going into 2019. Some will argue that this came off the back of political pressure, though some of the recent data show that aggressive USD buying to reflect economic outperformance in the US looks overstretched. Looking across the spectrum of major currencies, we can see the likes of AUD and NZD have redressed some of the excessive positioning in recent weeks, though all USD rates moved in tandem and to a similar degree in the North American session last night.
Rather than jumping in and assuming these moves would continue, we thought we would wait to gauge the reaction from liquid markets through Europe this morning. Price action this week will be heavily distorted from month-end flows, where USD demand is and was anticipated in light of rebalancing requirements after heavy losses in US stocks this month. Once the dust settles, we may have to wait until next week to get a true gauge of how current positioning will be affected by the latest Fed communication, with the benchmark 10r Note only now testing the $3.00% mark. In light of this, we would have anticipated a little more downside in USD/JPY specifically, though correlation traders will likely have been mesmerised by the relief rally in stocks which saw the Dow ramp 600pts, on par (in percentage terms) with the leading S&P. The NASDAQ regained some 200pts, though we should have anticipated the positive impact on stocks however temporary it may.
Into the weekend, fears over the Trump-Xi meeting should see some risk pairing, though it is now clear to see that equities need all the help they can get from any form of accommodation, and last night, Powell’s address proved that in spades.
In the background, the Fed is still (albeit very gradually) shrinking its balance sheet, so this slow retraction of cheap money should start to erode any near-term bonhomie seen in stocks. Eventually, we expect this to start impacting on the traditional safe havens such as the CHF and JPY, though I maintain that the latter is largely a case of repatriation risk as markets finally realise the US stocks are no longer the Golden Goose which keeps on giving. Naturally, emerging markets will even more vulnerable as USD liquidity contracts, so USD demand is also likely to hold up to some degree, but it is a matter of picking your targets. As above, we may see those currencies which have gained ground start to suffer.
More immediately, the EUR and GBP are easy targets for those looking to maintain a level of positive USD bias irrespective of the interest rate backdrop. Strength in the greenback is as much above safety as well as perceived demand from those burdened by USD based debt, so we expect to see a level of resilience in the face of some potential walk back from the Fed.
EUR/USD looks set to trade water in the 1.1200-1.1500 range in the meantime and we are far from comfortable in calling for a base in the leading spot rate as yet, with growth in Germany suffering from low export demand with the auto industry in the spotlight at the moment. Should we see the US offer an olive branch to the EU, then we could see a little more optimism here, but for now, sellers are ready and waiting to pick off rallies with pre 1.1400 a clear example this morning.
BP will remain pressured into the parliamentary vote set for next month. Few if any believe the current deal can pass in its current form, and at the very least, we expect the DUP to maintain their pressure on the PM to seek an alternative route. The threat of retracting their current confidence and supply agreement will further embolden the hardliners within the Tory party. Labour and SNP continue to argue for a second referendum as they see current membership more favourable than any proposed deal, and GBP traders smell blood once again as pressure on the 1.2660-1.2700 zone remains vulnerable, to say the least.
It is worth noting that speculative positioning seems relatively light based on the data at hand, and may explain some of the hold up seen ahead of 1.2700 in recent sessions. EUR/GBP, however, looks to be a more appealing play for a potentially bearish outcome, with growing calls for parity in the event of a disorderly EU withdrawal. Neither side wants that, no one wants that, but strong political red lines show a lack of flexibility which continues to heighten fears of a breakdown in the UK-EU relationship.
The story that the Fed could rein in their rate profile next year has been gaining traction in recent weeks, and it has been hard to ignore when there have been tentative signs in the US data that a higher rate environment is impacting on the economy. The recent drop seen in the NAHB housing index gave the markets a sharp jolt, though, before this, the ISM PMIs also suggested tighter financial conditions are starting to rein in business activity. It would have been somewhat short-sighted to believe that with higher rates and an ever-strengthening USD, there would be no impact on the growth dynamics.
Now we have a situation where the Fed could start to reassure markets that data dependency prevails and that a rigid path of normalisation should not be counted upon. This has tempered the outlook in short-term interest rate futures market and may well prove to be supportive on the mid-part-longer end of the yield curve, though into Dec, we may see the strongest reaction in the USD itself. Fed chair Powell is due to speak on Wednesday evening when he gets the chance to prep markets for any potential softening in forward guidance. He will be preceded by vice chair Clarida on Tuesday.
This week, however, we are looking to another month end of USD demand, as rebalancing requirements are pointing this way given another bout of heavy losses on Wall St equities. The return of stock markets today has seen a rebound in all the major indices, though, for material traction, we still feel the Fed will have to offer some solid indication of restraint. Indeed, today’s rally may be a case of pre-empting this scenario, as well as technical levels and an oversold status in the short term adding to the near-term relief.
In line with this price action, USD/JPY as wasted no time in pursuing the upside as we make a beeline for the mid 113.00’s if not 114.00, though the Fed meeting next month is a double-edged sword for the JPY spot rate if yields start to come off again – recall 10yr testing 3.00% and dragging USD/JPY back through the mid 112.00’s before basing out around 112.30 or so.
Elsewhere, EUR/USD will have a task and a half to push back and sustain the 1.1400-1.1500 area. Eurozone data gives little incentive to price in higher levels in the EUR just yet, with some possible flexibility from Italy in its budget considerations providing the modest relief early on Monday morning.
The EU Summit’s agreement of the withdrawal text and the declaration were also cause for some EUR upside, just as it was for GBP, though the latter lacks conviction either way as investors choose to sit this one out on the sidelines until we get more insight into the balance of sentiment in parliament over the deal. Cable support at 1.2790-1.2800 is the closest prop for now, while 1.2925-30 was evidently a push too far after last week’s initial response to the deal PM May brought back from Brussels.
Risk sentiment may have stabilised in Monday’s session, though this has failed to translate into any upside in the AUD or the CAD, with oil prices also edging back up again. As a result, we can only assume market players are looking lean on the anticipated month end flow expected into Friday, which could see a push for new USD highs over coming days.
Above is a weekly EUR/USD chart – I have outlined a potential bullish scenario but some conditions have to be met in order to confirm the theory:
- Looked like we had a rejection on the weekly candle last week
- We now struggle at the 50% Fib retracement that is acting as resistance
- On the downside, we failed to reach the 1.27% extension and 61.8% retracement
- A move weekly close higher could confirm the bullish sentiment
- Right now we may be at an ABC correction after the 5 wave Elliott pattern from 1.0340 to 1.2555. If this is the case we could be in for a correction higher
The daily chart contradicts the view on the weekly:
- The daily chart has turned higher but in recent days the USD has resumed control
- A firm break of 1.1545 is the confirmation needed to back the weekly Elliot Wave theory
- We are in a phase of lower lows and lower highs
- This extension lower stopped nicely at 1.12 area which is also the 61.8% retracement level
- There is also a resistance at the trendline running from the start of 2017 to the last wave low
- A break past the 1.1550 would confirm the move higher but it may be resisted
All in all, there is some traffic in the way but the risk/reward looks attractive. I must stress the conditions have to be met before the outlook changes to bullish. Each time the sentiment looks like it’s about to change another wave of USD buying comes in so keep risk tight.
Since the end of last week, we have seen the narrative that decelerating (rather than fading) economic momentum at this stage in the US has, and may well continue to lean on the USD in the near term. Something we have been keen to stress in the last month or so is the combined effect of a tightening Fed and a stronger USD, which then start to prove restrictive – or less accommodative as the Fed would put it. It’s not rocket science, but we have seen this time and again. As a function of the market overextending fundamental themes, we have therefore reached a point where the Fed now have to actively consider whether maintaining their current rate profile is ‘prudent’ – a term used by Harker last week.
Even so, the USD rally is not all about yield differentials, though naturally they come into play and provide an added draw for the greenback. With little appetite to carry risk elsewhere, it’s default status is as strong as it has ever been. Europe – or rather the EU – is doing little to soothe investor concerns with its disapproval of the Italian budget, while trade tensions have been hurting all major exporting regions. It is pretty clear what is hampering GBP at the moment, so we won’t go there! Asia’s current malaise is clouded by worries over a potential slowdown in China, exacerbated by worries over private debt, though with focus on the impact of US tariffs. There are signs that this is also feeding into the US manufacturing sector, as highlighted by the ISM surveys. For now, we will concede that protectionist measures are effectively a lose-lose situation, yet with the ultimate loser being the consumer, it stands to reason, that domestically generated growth (rather than export-focused) based economies will eventually suffer also. We need to listen to some of the doomsday scenarios on UK inflation should we settle on WTO rules!
Yesterday’s NAHB house price index also raised some eyebrows as we saw a drop from 68 to 60, so with the US being far from immune to personal debt dynamics, we expect to see a challenge – to some degree – of the USD as the out and out safe haven. Liquidity is a huge draw, but there is room for some differentiation here and the resilience in Gold price leads me to believe that we could start to see this gain traction soon.
Adding to this view is the all too modest pullback in USD/JPY. It’s equal resilience to the downside has also endorsed the USD in times of flight to safety, coerced by the BoJ’s insistence that it will keep printing JPY in order to get inflation moving. It’s not working – and why would it when we continue to see the divestment mill pushing funds into higher yielding overseas vehicles, and in its obedience, the market seems to be more inclined to tow the central bank line.
In conclusion, the signs are there that the USD seems unlikely to give up any material ground just yet – USD/JPY is telling us that. For the EUR to gain any serious traction back towards longer-term fair value will require the EU to try and calm matters with Italy. Red lines are all over the place, however, as we have seen in the Brexit saga, so political ideology (intransigence) continues to weigh on sentiment. Even so, just as we saw the market trying to squeeze blood out of a stone at 1.2500 earlier in the year, we may well be seeing the same ‘destructive’ pattern in ignoring current valuation levels in the USD. Volatility can be a positive ‘pressure valve’ (if you like), in smoothing out exchange rate averages over time.
It won’t have escaped anyone’s notice that the US equity markets have been in an astonishing bull run which has outpaced expectations for many, and some. Based on the availability of cheap money, the heavy composition of buy-backs has accentuated the move on Wall Street to levels where valuations are not only high but largely seen as overstretched when taking into account the pace of growth in the real economy.
However, in recent week’s and months, we have seen jitters in the major US indices, more notably in tech stocks, when US long end rates have neared key levels. The 10yr Note has tipped the 3.25% mark while the 30yr got tantalisingly close to 3.50% and the sell-off (in stocks) was not pretty.
This has prompted some to suggest the Fed may rein in their aggressive tightening path, which is in direct response to an economy close to, if not at full employment, while inflation is also picking up, based on the data received by official sources. Some are sceptical that inflation is as strong as is reported, but going off core PCE, there is pick at least – something the Fed were patiently waiting on through 2017 under chair Yellen’s leadership. Now we have it, Powell and Co are applying the brakes, with a terminal rate of 3.50% suggested by the dot plot.
However, the ECB and BoJ remain in an accommodative mode and come the end of December, the former will have ended their asset-buying program, though the focus is on Japan, where central bank and institutional buying of US assets continues. Whether this will do so after another jolt to the downside (on Wall Street) remains to be seen, but there is still cheap money out there and it continues to support equities.
While the BoJ suppresses JGB yields on the 10yr to 20bps, it is hard to see how this QQE can filter back into the economy and reflate prices, though there are structural issues which point to anaemic consumption, while savings – which exacerbate divestment for yield – continue to bolster assets with higher returns.
Next year will be the more interesting for global equities, which have shaken off a range of risks including trade wars, systemic risks from Brexit as well as an EU slowdown (hampered by populism). However, there is also the combined effect of a potential slowdown in the US, with the effect of the tax cuts working through the current cycle, a well as a higher rate environment. Japan will also have a higher debt to GDP ratio which is already in excess of 250%, and it is hard to see how they will be justified in maintaining this path if inflation has not materially worked through. There surely has to be an endpoint at which one has to say this is not working. What then for stocks