Three Price Action Questions in the Air for Next Week

2016-10-14 14:28:00

Talking Points:

- This week saw an aggressive top-side breakout in the US Dollar as driven by hawkish Fed commentary and meeting minutes; but does this move have staying power?

- The early signs of import inflation have shown up in the U.K. with this week’s ‘Marmite crisis,’ but will inflationary data next week further illustrate this as a pressure point for the U.K. and, in-turn, the Bank of England?

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Global markets are balancing a few key factors at the moment, and as we approach the November FOMC meeting just one week ahead of U.S. Presidential elections, and the potential for volatility certainly exists in many key market segments. Next week’s data calendar is highlighted by a European Central Bank meeting on Thursday, and in today’s article, we’re going to look at three of the biggest questions to be answered in markets around price action next week.

Does the USD Breakout Have Staying Power?

This week has seen the US Dollar has stage a top-side breakout, running above the July swing-high that we pointed out on Tuesday of this week. And after pulling back yesterday, price action found support around the same point of prior resistance, giving the appearance of continuation potential of the top-side move.

This, of course, has been driven-higher by hawkish Fed comments; starting as of a couple of weeks ago as the idea began to be floated that, perhaps, low rates are more of a recessionary risk than actually kicking rates higher. This may actually produce the situation in which the Fed expects that rate hikes could bolster the economy in the long-term; but the short-term pain of such a scenario could create considerable pressure in global markets.

So, there are two big questions to answer here: 1) Is this idea of rate hikes becoming pro-growth gaining greater traction at the Fed and 2) are FOMC members going to continue talking up the prospect of higher rates. The results of these questions are going to determine whether or not this USD Breakout has staying power.

Chart prepared by James Stanley

Are we about to see import inflation really show up in the U.K. economy?

There are quite a few upsides to a weaker currency, and the past seven years of global Central Banks embarking on various policies to weaken their currency highlights this drive. But, there are downsides as well. One of the biggest downsides of a weakening currency is the fact that imported products (brought into that economy, but represented by a different currency) will often begin to rise in value. If I’m an American or European producer selling products in the U.K., the weakening pound will mean that I bring back less to my native economy. So, the only option to try to offset that is to hike prices, and this is when inflation begins to show.

This week saw the ‘Marmite crisis’ in the United Kingdom, and earlier in the year when the Canadian Dollar was putting in an extreme move of weakness, we had the ‘Canadian Cauliflower Crisis’ as yet another example of this concept playing out in reality.

The big question is how inflationary pressure, particularly on imported products, may drive the Bank of England’s rate decisions and forecasts moving forward. The BOE has been extremely dovish in consideration of the uncertainty around the Brexit referendum. This extreme dovishness has played out in the Pound, driving the currency to 30-year lows. But, if inflation is beginning to creep into the economy, first through imports, will this moderate the bank’s stance towards future dovishness?

On Tuesday, we get British inflation figures for September, and this could highlight how aggressively this threat of higher-than-expected inflation may become.

Trading GBP likely isn’t going to be very easy, as markets in ‘panic mode’ often have a tendency to display lower levels of liquidity. And this lower liquidity can become problematic in and of itself, as there is simply less of a ‘buffer’ in markets to moderate price movements as new information is filtered-in, such as inflation data that could become a key determinant for a Central Bank’s forecasts and outlook.

We had looked at this setup in GBP/USD on Wednesday of this week, and below, we’re looking at the updated chart of that setup. Price action has essentially been moving into a wedge-like formation after the flash crash last week. This can give the allusion of support building, but traders should be really careful with buying support in a market that’s been showing a tendency to bleed-further. Should inflation come in well-above expectations that could potentially change the state of the current trend in GBP, but more information will need to be seen on that front before this can be considered ‘likely.’

Chart prepared by James Stanley

Is a ‘big’ bout of Yen weakness the next ‘big theme’ for global markets?

Central Banks have become the preeminent drivers of price action in most global markets. What started off with the U.S. doing QE turned into Japan taking the reins in 2012, and then Europe in 2014. As each of these QE announcements or programs were being implemented, traders around the world had a fresh drive of demand to try to get in front of.

The Japanese run of Abe-nomics lasted just a little under three years, and really began to come undone last year as the Chinese economy began to really slow down, and as Chinese regulators revaluated the Yuan’s floating rate peg. So Japan is in a tough spot, and for Japanese policy makers the decision set is essentially ‘figure out how to do more QE’ or ‘do nothing at all.’ These policymakers are well aware of what happens with the latter of those approaches.

The Yen has been putting in weakness over the past two weeks; and USD/JPY is showing the early signs of a trend reversal as a recent ‘higher-high’ has been set after the pair spent three-and-a-half months building in a series of higher-lows.

Should Yen weakness continue throughout next week, this makes the prospect of an extended bout of Yen weakness appears that much more likely.