Dow and S&P 500 Their Worst Week in 2 Years, Dollar Holds the Line
- US indices suffered their worst week in two years while the VIX has charged to well above its average trading band of the past years
- Traders have been on edge over a collapse in poorly-backed risk trends for some time, but we shouldn't presume systemic turn yet
- Asian markets' Monday open; the Dollar's fundamental bearing; and BoE, RBA and RBNZ rate decisions are key next week
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A First Stage of Risk Aversion
Volatility and risk aversion bookended this past trading week. The fundamental dam of worry based on protectionism and monetary policy led to a critical first break for benchmarks that had not had to deal with a sanity check in months. The aggressive trend channel break and resultant gap for the S&P 500 on Tuesday drew our attention to the over-extended nature of the markets and perhaps the ill-prepared state of the speculative rank that had grown comfortable without having to hedge or react to serious risk. Yet, as the themes of normalizing policy, valuation gaps and emergent trade war stories faded mid-week; it seemed that a systemic trend reversal had been averted. That confidence was struck down however, with Friday's equally-intense plunge. The S&P 500 and Dow each suffered their worst daily performance since September 2016 and rounded out the worst week in two years.
Risk Aversion is a Global Affliction
If we are to expect a deep and lasting reversal, it will not be an isolated affair. Whether US equities, emerging market assets or any other major investment group; there is rarely an independent trend to develop for one that strays far from the whole. Further, abrupt moves from even dominant benchmarks or assets in the speculative portfolio rarely motivate systemic recalibration. Sentiment itself - outside the construct of a single region or asset - is the great unifier that can stage lasting trends. And, to that point, we have seen early evidence of growing concern far and wide. Emerging market, high-yield, European, Chinese and other categories of assets have experienced pressure over the past weeks. Should correlation across the wide range of assets meet intensity in deleveraging, it would represent the most powerful signal of risk aversion we have seen in years. As such, traders from all corners of the world, should be watching the Tokyo open to see how readily the pain carries through the weekend.
The Dollar's Focus from Protectionism to Risk Trends
An interesting character in the global play this past week - and moving forward - is the US Dollar. At the start of this past week and months before, the Greenback has remained under serious pressure. The motivation for this decline has evolved over time: from the collective strength of its most liquid peers to concern of protectionism and credit quality more recently. Yet, risk trends has long remained an uncertainty for the currency. Would it suffer for the carry appeal that it has built up over time as the Fed raised rates at a steady clip while its global counterparts persisted with aggressive dovish policies? With the steep and broad decline in risk assets this past week, we had the chance to put the Dollar's allegiance as a carry or haven currency to the test, and it seemed to align to the latter role. The steady 2017 retreat and shift in focus to distant ECB rate forecasts may have shifted the burden off of the benchmark currency’s shoulders.
Themes and Events to Focus on Ahead
First and foremost, traders in all assets and of all analysis techniques should keep a vigilant eye on risk trends. Whether you are looking at the fundamental cues, the technical correlations or the systemic participation aspects of this overarching influence; it carries the greatest reach and thereby threat/opportunity. However, for those looking for more discreet catalysts and trade fodder, there are certainly stand out price developments and docket items. The Euro and Pound are both over-extended, but the former doesn't have a particularly established event on the calendar. Sterling on the other hand will be wrapped up in Super Thursday - the Bank of England policy decision that includes the Quarterly Inflation report. Two other rate decisions are on tap in the RBA and RBNZ meetings, and both currencies have proven particularly troubled after long trends (AUD/USD, NZD/USD) as of late. We discuss theme, events and opportunities ahead in this weekend Trading Video.
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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.