S&P 500 Recovery Perhaps at Greater Risk to ECB Decision as EURUSD

S&P 500, EURUSD and USDCAD Talking Points

• The recovery in risk assets continued this past session, but it still looked like a ‘mere recovery’ rather than charged bull as the SPX tempo slackened
• Event risk will pick up against starting this session with the ECB rate decision on tap, but EURUSD may not be the top option for volatility
• The risk that the ECB may pullback from its anchor position as a stalwart ‘dove’ may threaten to again undermine sentiment critically dependent on central bank support

The Recovery Slows as the Hurdle for Conviction Comes Into View

The recovery from Monday’s tumble extended to a second day this past session, but conviction seems to be wavering as the possibility of escaping the gravity of the summer doldrums comes into view. We are still dealing with a curb on general market participation and turnover that has cut short so many nascent efforts to establish a clear trend these past few months. To override the market’s buffers, a common motivation would do well with correlations still high. That said, there aren’t many measures or themes on hand that would cater to the ‘risk on’ trajectory that is currently fading. If anything, the lurking fears of the rise in global coronavirus cases, the moderation of the economic recovery pace and a slow but measurably turn in monetary policy all threaten the comfortably complacent advance. For now, I will be keep to the S&P 500 as a baseline for sentiment. If we can breach a fresh record high above 4,400 or return to 4,250, it could project the market’s intent.

Chart of the S&P 500 with 50 and 100-Day Moving Avgs and Daily Change (Daily)

Chart Created on Tradingview Platform

As a reminder of the themes most capable of commanding the mass’s imaginations/fears, my Twitter poll post-Monday’s selloff suggested fear over the delta variant spread received the handy majority of votes with 47 percent. From Google search traffic, it seems interest follows that same concern. Global search interest these past three months show search activity for ‘delta variant’ have overtaken ‘growth’. With another wave of coronavirus cases, there seems a deeper degree of skepticism that most of the largest economies will be willing to return to lockdown and take another gouge out of their economies. A data point isn’t necessary for fear to spread into the financial system, but such eruptions are very unusual in thin markets. Alternatively, interest in growth may find a foothold in the heading into the close of the week. The advanced July PMI figures for Australia, Eurozone, Germany, France, UK and the US are due Friday. Given how much enthusiasm is priced into our current perch, I would say that the greater potential is for a disappointing prints.

Twitter Poll on What Was Driving Monday’s Risk Aversion

Poll from Twitter.com, @JohnKicklighter

Thursday’s Top Event Risk May Be a Bigger Catalyst for Risk Trends than for the Euro

The third theme that I’ve been keeping tabs on offers up the most pressing fundamental potential through today’s session. Monetary policy can seem a convoluted matter for many traders, but I see it in two forms: a relative value consideration and a collective influence on underlying sentiment. EURUSD will certainly be the focus for Thursday’s session given the top event risk is the European Central Bank’s (ECB) rate decision. In the past months, we have seen a material shift towards moderating the extremely accommodative monetary policy stance that the world has been driven to through years of financial crisis recovery and then a year of pandemic-forced recession. The Bank of Canada and Reserve Bank of New Zealand have announced tapers, the Reserve Bank of Australia and Bank of England have suggested their own trimming, and the Federal Reserve has projected ‘early’ (relative to counterparts) rate hikes. Throughout, the ECB has maintained its position as one of the dovish hold outs. If it maintains this position, it could urge the Euro lower, but it would be more or less expected. Alternatively, any evidence that the world’s second largest central bank is following its peers could spur a rebound for pairs like EURUSD, EURGBP and EURJPY which have slid markedly over the past weeks and months.

Graph Of Relative Monetary Policy Stance Perception of Major Central Banks

Chart Created by John Kicklighter

The implications for the ECB decision to influence the Euro are distinct as the scenarios are relatively straightforward to project. That said, I believe the greatest fundamental weight from the monetary policy event would be the repercussions to general risk trends should the group join its US and New Zealand counterparts to project a path back from the seemingly limitless support for market participants. With another major player plotting its withdrawal, the recognition of individual risk in exposure (highlighting the moral hazard) could motivate more permanent de-risking. Below is the S&P 500 overlaid with the aggregate stimulus pumped into the financial system by the largest central banks. I believe this to be a relationship of ‘causation’ and market’s are forward looking. The risk is large and impact of the different scenarios disproportional.

Chart of S&P 500 Overlaid with Aggregate Central Bank Balance Sheets (Monthly)

Chart Created by John Kicklighter with Data from Bloomberg Terminal

Assets to Watch With and Without Catalysts on Tap

For assets to watch, EURUSD would seem the most obvious given the influence of the ECB decision and the knowledge that the Fed decision is now less than a week away. To be sure, this pair is likely to find a break from its extremely narrow trading range soon. The 15-day historical range and realized volatility (ATR) are extremely low at levels comparable to what we saw back in January 2020. That said, a bearish move has plenty of additional layers of support and would likely come on the curbed potency of confirming a dovish stance. A bullish break would be best served from a hawkish shift and carry into range which is less intimidating for those worried about liquidity. I would also keep close tabs on EURGBP which has a vary narrow range.

Chart of the EURUSD with 20 and 15-Day Historical Range (Daily)

Chart Created on Tradingview Platform

While the Dollar is often the foil to the Euro, I don’t believe the Greenback would be easily roused by the ECB decision. However, the Greenback has been remarkably active this week. Interestingly, the ICE Dollar Index’s four-day crawl higher finally broke this past session, but implied interest rate hikes from the Fed and US 10-Year Treasury yields actually bounced. Therefore it seems the retreat is more akin to a move back to the mean – or simply an easing of an ill-fated breakout attempt for the non-statisticians. AUDUSD and GBPUSD both bounced from their Dollar charges, but I think USDCAD was most impressive. One of the biggest daily slides in a year, pulled us right back below the 200-day moving average and long-term Fib levels. I will withhold judgement on conviction until we see a break below the 20-day moving average at 1.2480 though.

Chart of USDCAD with 20 and 100-Day Moving Averages and Daily Change (Daily)

Chart Created on Tradingview Platform

Notably, for USDCAD and other pairs attempting a bigger run, the retail trading crowd was leaning against the moves from the start. This is not clairvoyance or a collective deep strategy but more likely a reflection of natural habits and cognitive biases. The shorter-duration trading time frames of retail traders and preference for overt technical levels tend to encourage counter-trend positions and favoring range conditions. Given that we are struggling to establish ranges, their views seem to align to prevailing markets. Always take time to consider your contrarian signals and ask why they should work.

Chart of the USDCAD with IG Speculative Positioning (Daily)

Chart from DailyFX.com with IG Data