The Dangerous Nature of Headline-Driven Markets in GBP, Oil
- Many traders flock to markets that are heavy in the headlines, but for professional or institutional traders, this can often be a warning sign that abnormal developments may be afoot. Be greedy when others are fearful, and fearful when others are greedy. If historical-like moves are taking place, this is when new(er) traders will often get greedy; but in actuality this is really the time to be fearful - as those moves can blow up against the trader just as quickly (or even more so) than they might be able to work to their advantage. This is a difficult-to-calculate risk that many professional traders will often seek to avoid. If you’re not already short before the plunge, trying to get short after could be a daunting and risky prospect.
- In today’s piece we look at two such markets in GBP and WTI Oil. Both markets have seen historical-like moves of recent, but one carries a historical inference (setup) while the other appears to be a little more unique, a little more disconnected, and quite a bit more uncertain.
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In yesterday’s piece, we looked at the resurgence of US Dollar strength after recent Fed comments made the prospect of a near-term rate hike, perhaps as early as November, look considerably more likely. At 2 PM ET today, we’ll get the meeting minutes from the most recent FOMC decision and this can add some context to September’s ‘hawkish hold,’ which has retrospectively been dubbed a ‘close call’ by Vice Chairman Stanley Fischer.
But USD strength hasn’t been the only theme of interest facing new developments across global markets; and in the coming weeks as more focus is paid towards US elections and the prospect of actual rate hikes from the Fed (in either November or December), the opportunity is certainly present for any of these themes to ‘take on a life of their own.’ Below, we look at two of the more interesting themes that have been and will likely continue to dominate the headlines.
The British Pound Breakdown
Whenever ‘historical’ moves take place in a currency pair the trader is faced with a difficult situation. If the move is truly historical, then there is little by way of historical inference to apply to the current situation. This is what we have with the British Pound at the moment: After news of the ‘Hard Brexit’ made its way to markets two weeks ago, the British Pound has been unable to catch much of a significant bid; prices have continued to drop deeper and deeper. There isn’t much help from the Central Bank, as the Bank of England has been fairly clear through their efforts that they want a cheaper Sterling in order to help ‘turn the corner’ through the volatility around the Brexit referendum. So this presents the rare situation where the fundamentals behind GBP and the technicals on GBP charts all appear to be pointing in the same direction (lower), and this has elicited some bold calls such as ‘Sterling is heading for parity.’
And maybe it is? Again, this is a historical situation and there simply isn’t any template or playbook to apply here. There was but one instance in which GBP traded below current levels against the US Dollar, and that was in 1985, and this was somewhat of a unique scenario. In 1985 the British Pound had fallen to a low of 1.0520, but this was more likely resultant of a really strong US Dollar. The Thatcher-led U.K. economy continued to grow while GBP was dropping; but the US Dollar was aggressively strong after a series of rate hikes from a Paul Volcker-led Federal Reserve in response to the growth from tax cuts and spending increases posed by Ronald Reagan. These higher rates drove capital into the Greenback, and that strong Greenback created trade imbalances the world-around. This, eventually, led to the Plaza Accord in 1985, and this is what helped to bring the British Pound back to life in the second half of the 80’s.
Chart prepared by James Stanley
So, is that situation applicable today? Probably not: More likely the British Pound is going to be driven by the headlines around the Brexit referendum, selling as ‘hard Brexit’ looks more likely and moving higher when/if Brexit looks delayed or perhaps even less likely. This isn’t a really attractive scenario for professional or institutional traders, and this can lead to lower liquidity in GBP-markets that can make volatility even more probable as each new headline elicits a rush of buying or selling interest.
Traders will likely want to remain vigilant and cautious if trading anything around GBP while this situation is developing. Sure, there’s volatility and the potential for considerably more; but this type of volatility can be rough to trade as it can entail quite a bit of whipsaw; and this is the type of utterly unpredictable situation that many professional traders seek to avoid.
Oil at a Critical Level
This is a strong example of how short memory spans around markets are or can be. Just nine months ago there were very legitimate concerns that continued falls in the price of Oil could trigger panic across a levered-up banking system that carried significant investment in energy. Chair Janet Yellen’s Humphrey Hawkins testimony in front of Congress helped to stop the bleeding on the morning of February 11th, and the Oil market hasn’t really been the same ever since. That low in Oil prices came in just above $26. Just four months later, the price had nearly doubled. The resurgence in Oil prices was driven by a couple of different factors, namely a) a weaker US Dollar and b) the prospect of lower supplies as producers discussed production cuts.
But those production cuts haven’t really come to fruition. For oil-producing nations that garner a significant portion of their GDP from energy exports, cutting production could be a daunting proposition. Sure, perhaps it helps move market prices higher for the rest of the world: But it does this at the direct behest of that Oil-driven economy. OPEC used to provide somewhat of a buffer for such situations as many Oil-producing nations joined forces to collectively bargain around such prospects; but for a global energy market that’s seen the rise of U.S. production as driven by horizontal drilling and shale extraction, this means that there is somewhat of a competitive factor going on here. As oil prices move higher, so does incentive to continue developing US production; thereby adding more long-term pressure to producer prices by the implication of additional supply.
Very similar to the British Pound at the moment, Oil is very much a headline-driven market. The difference between the two markets is that Oil has somewhat of a historical inference with current price action which we can apply, placing additional emphasis on this year’s high of $51.64.
By drawing a trend-line from the low set in 1999 to the low set in the year 2002, traders can see a strong inflection taking place around the Financial Collapse. But perhaps more interestingly, price action in WTI has continued to draw back towards that trend-line projection over the past 20 months: first as support in the midst of the deluge in prices in early 2015 and more recently as resistance in latter 2015 and mid-2016. This year’s high, at $51.64, reversed off of that trend-line projection. Earlier this week, price action attempted to make a new high but was rebuffed less than .10 below that level.
Should prices in October reverse around this trend-line projection, traders can look to play a longer-term or ‘bigger picture’ reversal in Oil. And this would, at the very least, allow for some element of risk management as traders can look to wedge stops above highs so that if their attempt at catching a reversal turns out to be incorrect, the damage can be mitigated.
Chart prepared by James Stanley
--- Written by James Stanley, Analyst for DailyFX.com
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