The third week of August saw a significant shift from the grayer area of risk sentiment to a clearer focus of risk aversion. Stocks plunged on Thursday and Friday with the S and P losing 500 points for two days in a row, the biggest drop for four years . Oil has fallen further this week and commodities with it. The pressure on emerging markets has tangibly increased and for them the slide in their currencies a thin hope of keeping pace with the withdrawal of investment and the capital flow away from the once massive scale imput. Capital reserves have shrunk due to the USD gaining strength but the Greenback came under pressure as well as hopes receded  of a September rate hike following the release of the FOMC minutes on Wednesday.

It was a dramatic week. Since China’s decision to devalue was announced, Bloomberg has reported that global equities have lost value to the tune of  3.3 trillion USD . The final straw, or perhaps more of a bale, for the market which has held its nerve albeit cautiously for the last few weeks, was Chinese PMI data which came in Wednesday at 47.1 missing an already contractionary estimate of 48.1, precipitating the sell off in equities globally. If that was not enough to send traders for the valium bottle, Greek PM Tsipras resigned leaving us to ponder on the consequences ahead for the Euro which itself, had a stunning finish to the week. How fundamentally reliable that may be, is something else that deserves serious reflection.

 

Be Prepared; Every Picture Paints a Story

Here on the charts, the equity drops just in the S&P 500 in the USA ;

 

 

 

 

and the same fate in the EZ

 

It was noted that there was volume pick up in the stock market but this was not reflected in the forex market.

 

The risk appetite has been much discussed and warnings have been a-plenty. We have of course been watching the VIX for some time and it should not come as a surprise that following so much equity action last week the fear barometer did the same; chart courtesy of stockcharts.com

 

The unwinding of the JPY carry trade showed up also in our AUDJPY pairing;

 

The bond market displayed a dual effect of FOMC perceived dovishness and a flight to safety which brought further pressure on the yields;

Here is the US 10 year yield, chart again from stockcharts.com

 

and the German 10yr yield

 

Be Prepared:The State Of Monetary Play

With the 2 yr yield closest to  reflecting US policy and on the conservative side of the speculation, the downside on the USD experienced in the last few days of the week may be limited but data will define this and these numbers are market movers.

The curve in the sense of most hawkish of the global central banks has not changed, but as always timing is everything and we have at this point no way of predicting how deep the USD pullback that has begun, may be. What damage China and inflation fears may bring to bare remains to be seen. When it comes to assessing weak to strong in the Forex pairings the edge remains with emerging markets and their decline. Commodity currencies may offer opportunity but in view of the reactionary forces currently in play they may take longer to re-establish.

There are other factors in play including data this weak which the market did not enjoy, CPI missed with a miserable 0.1%,  building permits missed also. The Empire State manufacturing missed by a mile and, although not considered vital it does hold a warning. It was neutralised to a degree by the Philly number which exceeded by a small margin. The final number of the week did little to help the sagging index or its outlook with a PMI miss of 52.1 v. 53.9. At least it is still on the right side of 50.

There is one other factor to bare in mind with the USD. If the shift to risk off continues and accelerates we can expect the move back and the strengthening of the currency as a safe haven. This all will take it’s own time.

The second contender may well make its bid to be the first. UK Inflation is not impressive ( but it isn’t anywhere!) but data is slightly improving including a modest CPI and PPI and a small dissappointment  in retail sales. Its always a mixed bag. February is now in the speculative radar as the hike month and again the market will be data sensitive. Whilst the trading community assess the devaluation of the USD however temporary, and remember the pros will soon return to their desks, the GBP may show it’s comparative strength.

 

Be Prepared; The Hidden Factors; Euro Hype

 The rapid rise of the Euro during the past week took some by surprise. Then again when PMI starts to show promise confidence in recovery may be expected to increase. Of course you would have to discount France as the number fell below the expectation and is well under the 50 barrier. But was that the reason for the rally? It is more likely to be the unwinding of positions that used the Euro as a funding currency when appetite for risk was rising not falling. It is as well, another indicator of the sentiment shift, if indeed further proof is necessary. And there is also the issue of over-extended shorts on the EURUSD as the momentum built for the anticipation of policy tightening at the Fed. The likelihood is that the rally in the Euro has more to do with US value re-alignment than it does with Euro inherent strength. Additionally it may prove wise to realise that the EZ cannot afford for the Euro to get too strong without some sort of further intervention. And then there is QE. Whilst the length height and extent of the rally cannot be predicted the sustainability in the longer term is not something to bet the farm on.

The EUR Index can be added to the chart monitors and the push through the daily 200EMA is facing a weekly resistance level depicted in the following chart by the green line above;

 

 

The China Syndrome

The co-juxtaposition of devaluation prior to PMI data all set against the context of sharp stock declines was a cert to produce anxiety in the inter-connected market place. There has always been a suspicion that the data coming from China via the government is somewhat massaged. Euphemism implied. The chart of PMI does denote cause for concern, chart courtesy of tradingeconomics.com

 

The truth is China is a concern too for its neighbours but it is not confined just there. As I discussed last week deflation in China is very exportable all around the world. Iron ore imports from Australia will be suppressed as will they also from Brazil another supplier of this commodity. Germany, their GDP weighted as it is on the manufacturing sector is also at risk. Nigeria relies on oil exports, of which China is high on the list. Copper exports from Chile. The list goes on and this is a world issue.

The grave situation for emerging markets continues to deepen. David Stockman, a US republican and former director of the Office of Management and Budget ,very anti debt accrual and admittedly a contrarian view supplied a dramatic outlook to CNBC this week when he opined that the world economy is set for ‘epochal deflation…the flip side of twenty years of massive credit expansion’ a world wide ‘debt super nova’ . Lets hope that is an exaggeration for tv audiences and for press ratings but there is not much doubt that the global deflationary embers have not yet been stamped out and the dropping PMI’s and PPI’s around the globe could well refuel it.

The Shanghai suffered further losses this past week.

 

The Chinese equity slump has already taken its toll in the US. And this point it would be wise to remember that the two economies best placed for recovery, themselves have critically low levels of inflation and as oil drops, upwards traction becomes more challenging to say the least. The US currently has inflation at 1.2% well below the 2% target the Fed are reaching for and the UK is still at a miserable 0% despite the hype.

One final note for now on China is equally sobering; a worrying 520 billion USD has flowed out of the Chinese coffers in five consecutive quarters.

Be Prepared; The Opportunities

 Patience is key to trade the USD long. Awaiting the duration of this ‘correction’ and an on-going assessment of the sentiment shifts will provide its clues. I will still focus on the emerging market and await the long opportunity in the USDSGD. In the meantime, and because of the comparatives involved, I will also be adding the GBPSGD and exploring also the Turkish TRY for shorting opportunities. Commodity currencies are still on the ’short’ list in more ways than one! These may take longer now to set up. The EURGBP will be of interest when signs of the Euro rally drying up appear (be patient!). GBPCAD and GBPNZD are still of interest but waiting for the volume to return will improve the timing (more patience). Euro crosses, especially against the commodity currencies will depend on the EUR index and I shall look for the daily close in reference to the weekly resistance levels. I will leave the EURUSD alone. Euro crosses can be considered against commodities but watch that Euro Index!

The Week Ahead

 The calendar provides the usual dose of catalysts;

Inflation expectations from NZD (do they have any?), Monday

EZ  Busness climate (Germany) , NZD trade balance, USD consumer confidence Tuesday

On Wednesday ; RBA’s Stevens speaks again and the USD gives core durable goods numbers.

A big day for the USA on Thursday with that critical prelim. GDP number and unemployment as usual.

The GBP has its turn for GDP estimate on Friday  US trade balance also

Saturday holds a further news day when Gov Carney speaks again (and we all know what that might mean so perhaps relevant trades off by Friday) and Fischer from the Fed as well.

To Trade Or not To Trade

Yes that is the personal question but volume will be back soon and set ups will become, we hope, more reliable and moves from them more enduring than we have witnessed of late. As they said in the Lion King musical , be prepared, it may not be a shining new era but we don’t want to be caught unawares.

How? Know your global macro environment, understand long and short term sentiment  After all, Mufasa’s story is based on Hamlet and we do not welcome the epithet ‘Alas poor trader, we knew him well!’

Judith Waker

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