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S&P 500 Makes a Worrying Break, Dollar Dragged Down With It

S&P 500 Makes a Worrying Break, Dollar Dragged Down With It

Talking Points:

The benchmark US equity index broke the post-election bull trend and shook investors used to the quiet and complacency

Risk aversion poses a threat to the Dollar given its dependency on risk trends to fuel rate expectations/appetite

• Weigh the differences between corrections between AUD/USD and USD/JPY as their ease of movement is very different

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Finally, some signs of life from the markets. US equities stumbled and dropped Tuesday. The move took out short-term technical support which has kept a tight leash on very controlled volatility in the financial system. Given the heights speculative benchmarks have been pushed to and the extent of complacency underlying the system, it isn't difficult to understand the conclusions that traders are willing to jump to with this tempting move. Yet, we should hardly call the match on the opening move - especially when we have seen this initial effort fall apart time and time again over the years. If the first 1 percent or greater decline from the S&P 500 in 110 trading days (the longest stretch of quiet in 22 years) isn't our cue, then where should we draw our conviction? Correlation across markets is a good place to start.

With a measured approach to speculative conviction, traders should operate in confines with what has proven more reasonable as trade structure over the past months. That is setups with shorter durations, reasonable targets, appropriately proximate stops, controlled size and following technical paths of lower resistance. A good reference to this latter consideration is the difference between AUD/USD and USD/JPY. Both would slide with risk aversion to their backs. For the former, however, a drop falls within a broader range that has been repeatedly covered over the past year. For the latter, a break of key support established in 2017 (with similar floors across many Yen crosses) is a first hurdle to cross and the follow through on the other side will come at even greater cost. Unless conviction is robust and deep, it is usually better to follow the path of least resistance rather (probability) rather than the largest opportunity (potential).

Also notable in this recent break is the slide from the Dollar. The DXY Dollar Index is closing in on the 'neckline' of its head-and-shoulders pattern. This traditional 'safe haven' currency is paying the price of its advantageous position at the forefront of monetary policy tightening. There is an unusual connection to risk for the benchmark currency, and that will shape a number of the majors. Yet, just as with the bigger theme, we should eye the motivation for the Dollar's next move with caution. A break above 1.0800 for EUR/USD or drop below 111.50 would be an exceptional push for the market. Alternatively, moves from GBP/USD, AUD/USD, USD/CAD and others can be motivated without the devastation. In the upcoming session, the docket is extremely light, which will free up investors' worries to fixate on the confidence in risk trends. The one exception will be the RBNZ rate decision. This central bank has a history of changing direction with little warning. For pairs like NZD/USD and NZD/JPY, we'd be dealing with competing cross winds; but AUD/NZD and NZD/CAD can respond aggressively to a forecast that entertains the possibility of hikes. We discuss the upheaval in the markets along with the tentative trade opportunities it teases in today's Trading Video.

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.