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EURUSD, GBPUSD and AUDUSD Top Volatility Candidates With Fed, Election, Trade War

EURUSD, GBPUSD and AUDUSD Top Volatility Candidates With Fed, Election, Trade War

2019-12-07 01:00:00
John Kicklighter, Chief Currency Strategist
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Fundamental Talking Points:

  • The convergence of range conditions, a channel floor and NFPs earned a Dollar reversal last week; will the Fed decision alter the course?
  • Britain will go to the polls Thursday for the general election, and Sterling volatility on mere polls suggests it will be a high-risk event
  • Trade war risk faces a critical deadline in Sunday's (Dec 15) scheduled tariff hike by the US on China if a Phase 1 isn't met

Remember: We Are Fighting a Dimming Light for Liquidity

As we head into the new trading week, the potential is remarkably high that at least one of the key events on tap through the coming week will prove a likely candidate for significant volatility. What's more, a few of these meetings and deadlines carry systemic-level influence over the entire financial system. Naturally, this is remarkable potential (or risk, depending on your view) but it is important to remember the context. Our current market environment is a particularly limiting one. We've seen yet another structural moderation in perceived risk levels as the prevailing speculative bid has hardened investors to perception of risk - led by benchmarks like the S&P 500 pushing fresh record highs dozens of times this year. Compounding that, December is known as one of the quietest months of the calendar year - an influence realized as much through self-fulfilling prophecy as it is a genuine market constraint. So, while we may face measurable volatility, set reasonable expectations for the breadth and depth of trend development.

S&P 500 and Each New Record High

Fed and ECB Decisions are EURUSD Fodder, But They Also Touch a Systemic Threat

Through the end of this past week, we found a rare confluence of market condition, fundamental event risk and technical positioning. The general environment is more conducive to range and congestion, which made the DXY Dollar Index's move into its 19-month rising trend channel floor a remarkable build up. With a five-day slide, we were stretching the short-term norms for consistency. Then, along came the combination of the US NFPs and University of Michigan consumer confidence figures. These data points command significant influence and could have printed poorly, but forcing a systemic break and reversal was a very tall order. Alternatively, favorable data would align to the other aspects behind the market. With payrolls beating forecasts by over 80,000 positions and the sentiment survey better than expected at 99.2, the strategic stars aligned. See how retail traders positioned around the event risk and technical picture via EURUSD.

EUR/USD MIXED
Data provided by
of clients are net long. of clients are net short.
Change in Longs Shorts OI
Daily -4% 2% -2%
Weekly 8% -11% -1%
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Change in NFPs and the Difference Between Actual and Expectations

Though there was a lot of analytic influence at work, the market ultimately followed the path of least resistance. Ahead, we are facing a far more loaded and singularly directed event risk for the Greenback. The Federal Open Market Committee (FOMC) rate decision is both an event for the US currency and for global investor sentiment. This is the last US monetary policy gathering of the year and follows three consecutive meetings of 25 basis point rate cuts. Both the policy authority and market believe this last meeting will pass without change. That said, there are a few other critical matters to watch in this event. This is one of the 'quarterly' Fed meetings in which the group is due to issue its Summary of Economic Projections (SEP) which includes forecasts for growth and interest rates. It will also be important to watch for any mention of alternative monetary policy plans for the future. There have been discussions over how to overcome limitations of traditional policy. Will they announce alternatives like the BOJ's government bond yield targeting?

Monetary Policy Standings From Extreme Doves to Hawks

It is that latter concern that astute traders should keep close tab on. There is an enormous amount of conviction behind this inflated risk backdrop based on the efforts of the world's largest central banks and the expectation that this group can maintain the buoyancy of many years of excess anticipation for returns. If this conviction falters, the ramifications to global markets would be severe. In the meantime, the world's second largest central bank and arguably its most dovish player, the ECB, is due to weigh in on its own efforts. There is no change expected from the group, but there is a very apparent rift opening within the group. There is a faction of the central bank that is very worried about the diminished effectiveness of extreme easing and that can foster distrust among market participants. Will newly-appointed President Lagarde keep the piece or are we reaching a tipping point for European (and global) monetary policy?

S&P 500 and Total Stimulus of Largest Central Banks

A UK Election and Very Sensitive Sterling

Another critical event on the docket for next week that doesn't exactly rise to the status of being an obvious global driver is the UK general election. While its capacity to sway sentiment in European, Asian and US sentiment may be limited; the impact it is expected to have on the British Pound is particular severe. If you want to know how much sway this impending vote can have, just look at the evidence of Sterling movement this past week on the mere mood derived from opinion polls. The Pound has charged higher to indicate tentative, high-level breaks from the likes of GBPUSD, EURGBP and GBPJPY. That is no small feat. The currency's rally is a reflection of anticipation for a Conservative majority. This is not a belief in one party over another as much as it is anticipation for a clearer negotiation position in the UK-EU divorce proceedings. If a path forward becomes clear, expect volatility. That said, don't assume it is a steady climb as there are many hurdles ahead for getting a Brexit deal done.

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Chart of GBPUSD with 200-Week Moving Average (Weekly)

GBPUSD and 200-Week Moving Average

Chart Created with IG Charts

The Scenarios Around a Critical US-China Trade War Event

Next to the UK election and monetary policy events, the scheduled deadline on the US-China trade war seems to garner far less interest among global traders. That makes sense to a certain extent. On the one hand, there is an undeserved optimism among investors that seems to arise more from complacency than it does genuine enthusiasm for trade relations between the two superpowers. The more technical influence though seems to be the recognition that the cutoff date is for Sunday, December 15th. That should be a serious red flag for the mindful market participant. Should there be a drop over the cliff in trade relations - the US moving forward with its threatened increase in the tariff list against Chinese imports - the economic impact would be severe, though not as severe as the chasm that would open between investor sentiment and reality.

The natural benchmark to watch for a US-China flare up is USDCNH, but influence this has had on growth measures fare and wide thus far should be an indication of the global threat that it poses. I am particularly partial to AUDUSD which has a remarkably strong (negative) correlation to USDCNH without the artificial, external influence from Chinese authorities. Consider the probabilities heading into next weekend. It is less likely that there is a firm announcement of failed negotiations ahead of the deadline, so the more likely surprise would be a bullish one for risk trends and AUDUSD - a breakthrough. Alternatively, if we head into the weekend without a resolution, it raises the risk of an escalation in the world's most prominent pressure point. That is not a very good environment in which to hold a long Aussie Dollar position into the weekend.

Chart of AUDUSD Overlaid with CNHUSD and 5-Day, 20-Day Correlations (Daily)

Chart of AUDUSD and USDCNH Inverted

Chart Created with TradingView Platform

If you want to download my Manic-Crisis calendar, you can find the updated file here.

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