The Daily Edge - A Complete Cross Asset Analysis

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US President Trump, in yet another attempt to manipulate stock valuations, managed to single-handily engineer a major disruption to the ‘risk-off’ conditions that had engulfed the market since last Friday’s ramp-up in the trade war escalation. Whether Trump hallucinated (manipulated) the market when saying China wants to return to the negotiating table after receiving a call or not, what’s clear is that he still holds the power and has the ability to move the markets by acting as a circuit breaker. The round trip in the Aussie as the primary G10 FX proxy for China left many scratching their head but that’s the dicey environment we live in as the volatility of Trump’s tweets also ramps up. The Canadian Dollar was another great performer, while the Kiwi lagged way behind. The pullback in funding currencies was especially notable in the Euro as the currency got hit from both angles (‘risk-on recovery’ + poor German IFO). The Sterling continues its low vol correction after the strong appreciation following Merkel’s optimism around a potential backstop solution before the Brexit deadline by end of Oct. Lastly, the USD has traded much more stable, attracting fresh demand flows, sandwiched between the outperformance of high-beta currencies and the underperformance of the funding currencies. We are far from being out of the woods as the sense is that Monday’s risk recovery has little for one to latch on as trade war discrepancies worsen. However, as manifested via price action on Monday, the risks of greater two-way street erratic vol are on the rise as Trump becomes fixated with keeping equity valuations afloat, even if his claims start being highly questionable.

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The Sterling, after a couple of days of retracing from its hefty levels, ended as the top performer again in a move that clearly manifests the market is pricing greater chances of the UK may averting a no-deal Brexit, even if betting markets still assign around a 40% chance of a no-deal Brexit this year. Funding currencies, with the exception of the Swiss Franc, did quite well in an environment where risk is dialing back after the trade optimism that Trump wanted the market to buy into has run out of juice. The USD index continues on a steady path of recovery after the aggressive sell-off from last week when the escalation in the trade war broke into new highs. Meanwhile, as one would expect when financial conditions tighten and investors decide to go ‘cash’ in equities and bonds keep the stubborn bid, high-beta currencies (AUD, NZD, CAD, EM FX) performed poorly on Tuesday, and after going through the technicals in a bunch of risk-sensitive instruments, the risk environment remains on shaky ground.

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The Sterling was the main mover, this time hammered lower, after a bold move by UK PM Johnson to prorogue (suspend) the British Parliament after it returns from recess for five weeks until Oct 14th, essentially leaving very little room for MPs to block any potential no-deal scenario ahead of the Oct 31 Brexit deadline. The Speaker of the Commons Bercow described the move by Johnson as a “constitutional outrage", quite a symbolic expression to tell you how heated the proceedings are in UK politics ahead of what’s expected to be an incredibly turbulent time for volatility to hit the GBP from Sept onwards. Amid the angst around Brexit and China’s trade, risk dynamics remain poor, which has undoubtedly contributed to keeping the bid tone in funding currencies, especially on the EUR after Italian Prime Minister Conte will finally be given the mandate to form a new government in Italy, which makes the prospects of a snap election dissipate a tad for now. The selloff in Italian yields relaxed the selling pressure on the Euro. A currency that attracted most of the demand on Wed was the USD index, on the verge of breaking a key resistance. Lastly, the hight-beta currency complex the likes of the AUD, NZD, CAD remain with a bearish outlook overall, with the NZD the worst performer after another terrible business confidence reading out this Thursday morning in NZ.

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The back and forth in the trade war keeps the market guessing, which is causing, as highlighted in yesterday’s webinar, an erratic two-way vol in the market. It took only one headline via the Chinese Commerce Ministry stating that discussions are still underway to keep the pretense of further trade talks going for risk appetite to be back in vogue. China also implied that a walk back in its retaliatory actions cannot be ruled out if the US creates the environment to do so. The US Dollar and the Canadian Dollar were the main beneficiaries, even if the performance of the rest of G8 FX leaves the impression that the push up in risk, which was quite aggressive in the S&P 500, is a half-baked type with participants applying caution, with the likes of the Aussie and Kiwi, which you would expect to do well under this environment, lagging behind. Even the Japanese Yen, in particular its equally-weighted index that I monitor every day, is not yet communicating any trend reversal. Same applies to fixed-income, little reaction with the US30y hovering around an all-time low. The Sterling remains in a wait-and-see mode, while the Euro is in no man’s land as I elaborate in the currencies’ section.

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The US Dollar has been the undisputable leader of the Forex board, especially during the last week of trading, in what became a rather eventful month of August, characterized by the escalation of the US-China trade war, with the latest announcements to hike tariffs coming into effect this last Sunday. 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 from distance 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.

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It was a quiet Monday for most of the currencies as the US and Canadian markets were closed due to Labor day, essentially clearing the landscape to make the GBP the absolute focal point as volatility, once again to the downside, hit the currency as the risk of a snap election in the UK is on the rise. GBP traders must be aware that trading the currency in the coming weeks and months is going to be a minefield of headline-charged price fluctuations, which increases the risks considerably. Meanwhile, the close of markets in the Western hemisphere didn’t make any difference to alter the steady uptrend in the USD, with the JPY and the CAD following from distance. The markets that appear most at vulnerable to further downside pressure remain the AUD, NZD, EUR, and to a lesser extent the CHF, which trades at fairly cheap levels based on the risk profile.

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After 2 years and a half above the boom-boost line of 50.00, the first contraction in one of the benchmark bellwether indicators of the US economic health (ISM PMI) has been confirmed, sending the USD lower, even if still under the context of a strong uptrend, as the odds of a 50bp rate cut by the Fed in 2 weeks go up to around 20%. The bullish steepening of the yield curve also sends a troublesome signal as any under-delivery of policies by the Fed will only exacerbate the disconnect between the Fed stance and the market verdict of where interest rate ought to be. A currency that continues to trade at the rhythm of its own drums is the GBP, with the juggernaut of two-way vol dominant as the UK appears headed towards a general election by mid-October as the Parliament is about to take away the Brexit negotiating powers from PM Johnson. The risk environment, when looking at the whole spectrum of sensitive assets (JPY, VIX, US 30y yields, SP500, USDCNH…) continues to communicate the market is acting rather complacent by keeping the AUD so well bid. The opposite is true when analyzing the low levels of the CHF. We know when trading the EUR, expectations over the beefed-up easing package by the ECB has been on the driving seat, but the divergence with the risk profile makes the soon-to-be-tested key support in the EUR index a highly anticipated area where a response to revert the momentum may ensue. Meanwhile, the CAD was taken to the woodshed ahead of what looks like a Wed’s BoC meeting with dovish risks.

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A quadfecta, which in horse racing refers to picking the first four winners, could be extrapolated to the order of positive news hitting financial markets as risk-seeking strategies thrive after four consecutive risk-friendly developments occurred on Wednesday. The withdrawal of the extradition bill by HK set the ball rolling, which considering is what sparked the beginning of demonstrations, it definitely was a good omen to start the day in Europe. We then must throw into the mix the delay of a no-deal Brexit as the UK Parliament took control of the process, only to see a new Italian government formed with Conte back as PM and former EU economic and monetary affairs chair Gualtieri as Finance Minister. The icing on the cake came after the Chinese Ministry of Commerce issued a statement that China and the US agreed to meet in October for trade talks. Needless to day, amid the rampant risk appetite in equities (not in bond yields though), risk-sensitive currencies (USD, JPY, CHF) were taken to the woodshed, while GBP, AUD, and CAD buyers blare the trumpets by riding the bullish momentum as key tail risk events (Brexit, HK, Italy, US-China trade) are all in recess.

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There is no doubt that the revitalization of the carry trade is back in vogue as high-beta currencies thrive at the expense of plummeting funding currencies, especially the JPY and the CHF, while the EUR is also under pressure even if trading dynamics in the latter will be determined by adjustments ahead of next week’s ECB meeting on Sept 12. Even the jaw-dropping pool of negative-yielding global bonds has come down significantly as we see the flourishing environment lift both stocks and fixed-income, which is a clear testament that the quadfecta of positive developments all compressed within the last 24h has shaken the grounds of the market in what has the risk of turning into a major reckoning moment in the re-adjustment of positions this Sept. You don’t often see that the underlying risks having worried markets the most in recent memory, without exception, get systematically reduced in seamless synchronicity. The market is currently undergoing an aggressive repricing as the perception is that through the course of Sept, there will be a relaxation of the chaos seen in HK, the political instability in Italy, the prospects of a hard Brexit, or a full-blown trade war with no intention to talk. It should be, therefore, not surprising that the market is coming to grips that as valuations stand, reversals back to the mean in risk instruments must eventuate to adjust to the new reality.

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As the short-term angst that used to radiate out of the US-China trade war, Brexit, Italian politics or HK protests continues to dissipate, the likes of the AUD, NZD, CAD keep finding mounting buying interest, with the contrast clearly visible in the underperformance of the JPY and CHF markets. In a week where the ECB will take center stage, the effects on the back of the synchronized quadfecta of positive news for risks are still reverberating around financial markets as key stock indices also confirm key breakouts. While the ‘easy gains’ in risk-sensitive currencies seem to have already been made, the overall outlook for risk to stay supported is the most constructive seen since late July as the analysis of the currency strength model conducted in today’s note aims to demonstrate. The ‘risk-on’ train is in full motion.

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Mondays tend to be a low key affair unless there is a disruption in the news flow over the weekend. The last 24h of trading was no exception, with the aggregate tick volume below the normal standards and the movements contained in familiar ranges. There were two currencies undepleted of healthy levels of volatility though, which include the Pound, boosted by an upbeat UK July GDP as the lingering effects of the no-deal Brexit bill still play out in the background, alongside the Swiss Franc, which we could dub as a “falling knife” at this stage after 3 consecutive days of sharp declines. The Euro found demand on the back of Germany’s shadow budget chatter, with the Aussie also following the Euro tail very closely as the quadfecta of positive developments last week has seen steady flows concentrated in the oceanic currency as the fav proxy play on China. The low-volatility Monday, nonetheless, had it tough in those looking to engage in trading the USD or the CAD, both undergoing painfully compressed ranges.

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The Euro keeps garnering further upward traction in the Asian session this Wednesday as the conviction over the boldness of the stimulus by the ECB is in recess. We have another 24h of technically-oriented EUR trading before all the bets go off when Draghi takes the stage on Thursday. The USD index, which finds itself in a value location (I elaborate on it in the charts section), may start to get more attention in what’s still arguably one of the healthiest macro trends in FX, even if the CAD is looking to challenge that status by making further strides from a technical perspective, as the index just broke out a key resistance level to print fresh yearly highs (not seen since Oct 13 '18). The Yen and the Swissy continue out of love as the risk appetite is retained, mainly courtesy of a surge in global yields this time. The effects of ‘risk-on’ conditions are failing to have the same positive repercussions in the Oceanic currencies or the Pound as compared to the dynamics from the last week, with the CAD and the EUR taking up the slack.

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The Euro heads into today’s crucial ECB meeting, which marks the end of Draghi’s tenure as President, with the downside pressure intact as the equally-weighted EUR index retests the very same low that led to the latest resurgence in the single currency’s demand the day of the last ECB meeting. Coincidence that we find the Euro in the same levels of sentiment as back when the ECB last met on July 25th? I wouldn’t say so as the valuation of the EUR is highly dependable on the ECB policy outlook, and since that last meeting, the preponderance of fundamental evidence for the ECB to act decisively has only strengthened, which is precisely what the market has been discounting ahead of it, therefore traders should accept as a premise to see further EUR weakness an over-delivery of policies by the ECB unless we see a similar rebounding episode akin to what transpired after the last ECB decision. Will the ECB announce a new QE program? What will be the size of it? Are they going to cut the deposit rate? by 10bp or 20bp? These are some of the most pressing ‘question marks’ the market needs clarity on, and by which the EUR will determine its next directional bias. On the rest of the G8 FX space, we have the Oceanic currencies, especially the Aussie, still flying as Trump delays tariffs to China from Oct 1 to Oct 15 in a goodwill gesture, while the funding-type currencies (JPY, CHF) remain on the backfoot with further downside in the horizon as the ‘risk-on’ dynamics stand. The USD is starting to find renewed buy-side pressure, which is the opposite of what we’ve seen in the CAD market in the last 24h even if the outlook remains quite promising. The Sterling has been rather comatose as the Brexit newsflow slows down.

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Draghi underwhelmed in the delivery of the ECB easing package, leading to (eventually) sellers being overwhelmed by the buy-side pressure. In the end, even if this time the cleanout of weak-handed longs went deeper than the last ECB disappointing meeting on July 25th, it was Deja Vu all over again (sell the rumor, buy the fact), as the market could not justify such a depressed EUR valuation after the ECB did the bare minimum to satisfy the overly dovish expectations, judging by the EUR behavior in recent weeks. The Swissy, this time detached from the shackles of its over-dependence in ‘risk-on’ flows, manage to find buying interest as it piggybacked the EUR from the distance. Surprisingly, and probably a testament of how over-extended these markets are, the AUD, NZD, CAD all pared back gains after the ECB even if bond yields and equities continue to rise in tandem as the US and China keep sweeting the risk appetite with a more constructive tone in the latest headlines. The USD continues to trade steadily when crosschecking its performance against G8 FX (not against the EUR as a standalone view), while the JPY sellers remain in the pain cave with not yet an end in sight. Lastly, the Sterling keeps behaving as one of the most unexciting currencies to get involved in as the flow of Brexit news peters out due to the UK parliament suspension.

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Traders are waking up this Monday to an ‘eye-popping’ move in the price of Oil, with Brent Crude up over 20% soon after the open, following the unprecedented accuracy in an attacked perpetrated in multiple Saudi Oil refinery facilities, claimed by Houthi rebel from Yemen. The attack happened in the world’s biggest crude production facility in Abqaiq and Saudi Arabia’s second-biggest production facility in Khurais. The ramifications were felt throughout the marketplace, from currencies to stocks and bonds. The immediate pattern during Intermarket hours has been quite predictable, with the Canadian Dollar, the Norwegian Krone and the Yen bought strongly. The first two on the basis of its strong correlation with Oil as one of the largest exporting nations, while the Yen gets a bid as the geopolitical risks are heightened as the US points its finger to Iran. In terms of the main losers, the Oceanic currencies AUD, NZD were hit due to the increase in risk aversion, with the Turkish lira and Indian rupee especially fragile due to the nations’ profile as heavily dependable on Oil imports. The key topic of discussion that the market is seeking out answers for is the length of the disruption before full capacity is back on track. Will it be just a matter of days, weeks, or months? Obtaining clarity in this front is essential to adjust the outlook for Oil and the wider market profile.

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It was a very busy Monday for Oil traders as the market digested the news emanating from Saudi Arabia after suffering the sudden loss of 5.7m b/d of oil production, which marks the largest outage the market has ever seen in volume terms, surpassing the level from the Iraqi and Kuwaiti 1990 Gulf War. The CAD, NOK, but also a firm USD, were the outperformers while currencies the likes of the Euro of the Kiwi were punished the most. The market continues to be glued to any relevant update from Saudi Aramco that may clear up the key question mark to set Oil fair valuation, now heavily dependable on how fast can the Saudi restore its Oil output back to full capacity. Note, in line with the rather benign risk environment prior to the events in Saudi Arabia, do not mistake the attack as an admission that the forex environment should turn more risk-averse as the preponderance of technical evidence is not yet there, neither in equities, fixed income or in the performance of the JPY or CHF, with most of the safe-haven bids at the open of Asian markets in the latter two rapidly evaporating as the day rolled along. Currency traders will have to soon be expanding its focus as a line-up of Central Banks comes up, with most of the attention placed in the FOMC. It is precisely this high-impact event that may have helped to keep the USD bid off a critical support in the index, as the market is at risk of a less dovish forward guidance tone by the Fed amid firmer US fundamentals and the US-China trade war justifying extra patience, even if that view may now be challenged if we see an increase in geopolitical risks in the Middle East. An underpinning factor for the re-emergence of the USD buying interest is the development in the funding market, where we saw a massive jump in 3-month FRA/OIS spread (3m LIBOR vs overnight index swaps), which implies a spike in USD demand in the system.

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As the price of Oil adjusts lower on the appeasing words by the Saudi Arabia energy minister that the Kingdom is set to return to full oil production capacity within 2-3 weeks, the market is in the transition period to accommodate and expand its focal point to the FOMC. The market sees the possibility of a 25bp rate cut as almost baked in the cake, even if Chair Powell has definitely earned time to take it easy as the US economic data has firmed up and the expectations for another US-China trade truce build up. Ironically, with a squeeze in the short-term USD funding market as the spike in the repo rate reflects (shortage of USD supply), which has caused the Fed to step up by injecting liquidity into the system, there is even talk that given how tight the liquidity pool is to have sufficient USD liquidity in the system, considerations may be given to a light return of QE. Interestingly, it was a day when both the high-beta and the risk-sensitive currencies lost value in absolute terms in the indices, with the European currencies taking up the slack of gains. The CAD felt the damage of a falling Oil, as did the AUD to a dovish RBA minutes outcome. The NZD appears to be playing more catch up with the AUD here. The JPY and CHF were not in high demand as the risk appetite remains supportive, especially in equities even if no backing from global bond yields in the last couple of day.The GBP and the EUR can be found on the other side of the spectrum as said, both rising with conviction, while the USD loses its shine a bit ahead of the Fed verdict on policy.

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The USD is trading higher as the FOMC validates my assumption of improving US economic data coupled with a tentative US-China trade truce in Oct acting as sufficiently convincing arguments to take the foot off the pedal, in other words, no longer committing/hinting to further rate cuts this year. This makes the disconnect between the median dots plot and the market expectations rather pronounced, with one more rate cut fully priced by the end of 2019 with the disparity only widening into 2020 and beyond. The JPY joins the USD as one of the main beneficiaries of the post FOMC contained volatility we’ve seen, with all eyes on the BOJ presser by Kuroda after an unchanged policy decision today. The GBP also continues its ascend, really defying gravity here as the market keeps pricing out the risks of a disorderly Brexit. The EUR and CHF had a mixed-bag day. The main losers include the AUD, knocked down after a poor reading in the Australian employment report (RBA rate cut calls on the rise), the NZD has also been trading on the back foot with the market not buying into a modest recovery in the NZ GDP release a few hours ago, while the CAD is also a tad lower, mainly dragged by lower Oil prices.

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The Sterling is hands down the currency running away from the FX pack in an upside direction, while the opposite is true about the New Zealand Dollar. The rest of currencies indices, when crosschecking its performance against a basket of G8 FX, are still sandwiched in rather compressed ranges, with the exception of the Aussie, as sellers start to make further strides after the conviction of another rate cut by the RBA in October gets priced into the Oceanic currency. The USD continues to show a benign technical picture in the index, which should bode well for the currency next week as the market readjusts the neutral policy stance by the Fed as the current base case. The EUR is also showing its most combatant side with further demand found in the European session but unable to be sustained through the North American trade. The CAD has been treading water for the past few days with very limited volatility in its index, while both the CHF and JPY exhibit strength after the market perceives the latest policy calls by the SNB and the BOJ as falling short of the easing expectation built ahead of the events. As a result, both currencies were boosted even if the technicals are still rather dubious at this stage.

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There has been a change of dynamics at the open of markets in Asia, with risk being bid again as signs of progress in trade discussions between the US and China were highlighted by the Chinese Commerce Ministry over the weekend. The usual suspects when optimism arises, that is, the AUD, NZD were bought back, with sell-side pressure applied to, most notably, the JPY and CHF. The CAD remains with a relatively stable outlook with the Oil up-gap this Monday to potentially act as a bullish contributor today. The USD is holding its ground quite firm with technicals in favor for further gains. The EUR keeps struggling at a supply area in its index, as I elaborate in today’s chart analysis, while the GBP saw a setback in the last 24h as reports emerge that the UK and EU are as far from an agreement to replace the backstop as ever. Today’s key highlights to act as an extra stimulus of price gyrations include EU/US PMIs and ECB’s Draghi testimony in the EU parliament.

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