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EURUSD and USDJPY Primed for Pre-FOMC Volatility After Data Surprise

EURUSD and USDJPY Primed for Pre-FOMC Volatility After Data Surprise

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S&P 500, USDJPY, Evergrande and Dollar Talking Points

  • A surprise US retail sales report beat offered the market an unexpected charge in volatility, but it wasn’t enough to break the S&P 500’s range
  • The focus remains on next week’s FOMC rate decision, but clearly there won’t be a cap on volatility that arises from important event risk – like the US UofM consumer sentiment survey
  • External risks like Evergrande and volatility outliers like gold should be closely observed while established ranges (EURUSD, USDJPY) pursued
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Benchmark Risk Measures Refuse to Commit While Outliers Move

There is little doubt in my mind that the speculative masses are waiting for the FOMC rate decision next week to commit to a clear bearing on their ‘risk’ views. However, that anticipation doesn’t restrict the impact of volatility around technical developments or fundamental headlines. This past session showed the power of the unexpected on market activity as a strong-than-expected US retail sales report charged the US Dollar and helped reinforce ranges for the likes of the S&P 500. Looking ahead to the final trading session of the week, the University of Michigan sentiment survey’s potential has been materially amplified for market-moving potential owing to the US consumer data. Yet, despite the potential for volatility, expectations for ‘true breakouts’ (with follow through intent) should run through the twin constraints of a weekend liquidity drain and anticipation around the US monetary policy event.

Chart of SPY S&P 500 ETF with Volume and 50 and 100-Day SMAs (Daily)

Chart Created on Tradingview Platform

While my baseline expectation for the coming session is a check – potentially volatility – of established ranges, there is of course a chance that the unexpected (black or gray swans) can unseat established technical patterns. The list of unknown threats is infinite, but the known concerns represent a relatively small list. Given the warnings that have developed recently, the situation around Chinese property manager Evergrande’s financial straights are of particular interest. The second largest real estate company in the world’s second largest economy can represent an outsized threat to systemic stability. This past session, Evergrande’s principal operating unit Hengda Real Estate Group put in a request to halt trading in its corporate bonds in advance of a missed Monday interest income payment. There is a remarkable level of assumption around the market’s ability to hold its general bullish course and subsequent belief in Chinese regulators’ capacity to contain serious fundamental fallout. That said, what happens if that confidence is broken?

Chart of Evergrande with Volume Overlaid with Shanghai Composite (Daily)

Chart Created on Tradingview Platform

What’s Ahead: Seasonality and Principal Fundamental Risks

One of the nagging considerations around the markets quiet as of late is the assumption that we are traversing territory that is volatility-prone. Generally-speaking, the S&P 500 suffers its only monthly loss of the year in September (given four decades of historical data) and this week has thus far settled on ‘unchanged’. That may seem an oversight an overdue correction, but it really seems appropriate for the circumstances. While the 37th trading week of the year – which we are currently in – is known as the start of a bearish string of weekly losses in seasonal charts, we are dealing with the full weight of anticipation for next week’s event risk. If we are going to give full credit to seasonal implications, it is worth learning the nuance of the data.

Chart of the S&P 500 Performance By Calendar Month

Chart Created by John Kicklighter with Data from Bloomberg

Another consideration feeding into my wait-and-see view of risk trends is the evaluation of what market participants hold dear. While I do consider markets over-indulgent on risk exposure and the UofM sentiment survey can tap into taper speculation, it is not surprising that there is considerable focus on what lies ahead into next week. Below is the result of my social media poll asking what traders thought the spark for an eventual reversal in risk assets may be. It is of no surprise to me that a taper and general central bank withdrawal was the top option, but the markets have yet to truly chew on those concerns. We, however, should consider those risks seriously.

Twitter Poll Asking the Greatest Risk for Risk Aversion

Poll from, @JohnKicklighter

The Dollar’s Rally and the UofM Sentiment Report Ahead

While the broader market is in a holding pattern – likely time limited on next week’s Fed decision – there is still a great capacity for volatility in these market conditions and against the fundamental restraint for consideration. For the Dollar (the DXY Index), this past session was a surprise bullish charge with retail sales posting a remarkably strong 0.7 percent headline growth for last month’s update against a -0.8 percent forecasts. That is a boon to economic forecasts, but it is likely that the market registers the implications for the Dollar and financial system at large. A strong US economy after the NFPs miss can help right the ship back on course for a Sep 22nd taper potential. As it stands, the Dollar is in a good position to charge higher into a larger range, but these are reserved times.

Chart of DXY Dollar Index with 100 and 200-Day SMAs, 1-Day Rate of Change (Daily)

Chart Created on Tradingview Platform

For markets that suit conditions, fundamental and technicals; there are few more appropriate markets to monitor than USDJPY. For many, the tight range that has developed these past weeks (months and years separately) is an opportunity all its own. Anticipating a break from this 110.50 – 109 range is a practice in excited assumption. Given the zeroed yield advantage here and the mixed ‘risk’ perspective, it would seem a high bar indeed to prompt USDJPY to a true break.

Chart of USDJPY 200-Day SMA, 20-Day Range (Daily)

Chart Created on Tradingview Platform

An atypical Dollar-based pair I would like to add to the ‘watch list’ is USDMXN. This pair brings together well-known carry and haven currencies. That said, the Dollar-Peso relationship seems unnaturally deflated. In fact, the 10-day volatility (ATR) and range are among the most restrictive active steps that can be taken short of a material alertion in exposure. In the meantime, USDMXN is carving out an extraordinarily narrow trading range with the range the lowest in over a decade. In turn, range trades seem more appropriate for the lockdown on turnover, but it can lead to changes in organize structures for which we will need to evaluate the risk.

Chart of USDMXN with 50 and 100-Day SMAs, 10-Day Range (Daily)

Chart Created on Tradingview Platform

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