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EURUSD and USDJPY Staged for Breaks as Fed Calculus Shifts, US Debt Limit Looms

EURUSD and USDJPY Staged for Breaks as Fed Calculus Shifts, US Debt Limit Looms

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S&P 500, Dollar, EURUSD, USDJPY and FXI Talking Points

  • Last week’s recovery charge from the likes of the S&P 500 lost all momentum through Monday’s active trading session
  • Key event risk like the FOMC rate decision last week or NFPs next week are lacking on this week’s calendar, exposing abstract fears
  • While China’s financial and economic health remains a possible trip wire, the Fed’s policy intent and a looming US debt ceiling hit create serious global concern
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The Recovery Tempo Ebbs and Volatility Expectations Remain

Even though we have passed a peak event risk in last week’s FOMC rate decision, there seems to be no relief from the buffeting fundamental winds around monetary policy along with the uncertainties of monetary and fiscal policy. That uncertainty has helped to drag the rebound in risk assets from last week to a halt, and it will no doubt lead to the next break from the narrow trading range that we start this new week out on. The S&P 500 capped its recovery rally from last week with a gap lower on the open Monday and what is ultimately a narrow enough trading range to fit neatly within Friday’s span (what technical traders call an inside day). If we were to directly interpret the fewer listings on the economic calendar as sign that the markets have easier terrain ahead, this would seem a natural start to the new trading week. However, the provocations of last week’s event risk simply roles into a minefield of expected breaking news around unresolved threats. I suspect a break from these very narrow trading ranges (in other risk assets and Dollar-based majors) will come soon, but direction and intent depends on what ultimately lights the fuse.

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

Chart Created on Tradingview Platform

While I believe the S&P 500 and other US indices to be very useful measures of risk trends owing to their seemingly relentless ‘buy-the-dip’ support, they tend to be more one-sided in their sensitivity and extremely resilient to the bearish view shy of extreme conviction. That can be useful, but it isn’t an early warning signal for any ebbs in conviction that turn into torrents. On that front, I believe speculative volatility products are better suited to gauging the charge of opportunism. The VXX short-term volatility ETN remains one of the more heavily traded of the inverse measures. Through the opening salvo of the week’s volume, there looks to be little intent to front run any impending sense of doom.

Chart of S&P 500 with 20 and 50-Week SMAs and ‘Tails’ (Weekly)

Chart Created on Tradingview Platform

While the markets seem to be in the twilight between rote speculative opportunism and concern of fundamental threats on the immediate horizon, I am reminded that seasonal expectations will factor into market participants’ actions. September is known as the worst month for risk performance according to the S&P 500, and we find the index is still underwater (by -1.8 percent) month-to-date. However, the weekly expectations are even more acute in historical terms. The 39th week of the year is the worst performance for the index, and 120 years’ worth of data should suggest this is data that should be taken seriously.

S&P 500 Weekly Performance Averaged Over 120 Years

Chart Created by John Kicklighter with Data from Bloomberg

The Fundamentally-Fraught Dollar

There is plenty of scheduled event risk for this week – including for the US Dollar which has a consumer confidence survey from the Conference Board due Tuesday. However, the potential for currency and market impact is far greater in the evolving fundamental threats we face this week. Monetary policy is certainly a sticking point with the a host of Fed speakers on tap, but consider the more loaded events with Q&As that can rouse more insight such as Today’s Senate testimony from Chairman Jerome Powell and Treasury Secretary Janet Yellen. And, of course, there is the low probability but severe potential threat in the US debt ceiling. The fiscal year ends Thursday and funding needs to be sorted to keep the government open as of 12:01 AM Friday. A government shutdown is not the same thing as a default, but similar brinkmanship pushed Standard & Poor’s to cut its AAA rating of the US back in 2011. This is a severe threat to financial markets both in the US and elsewhere and should not be brushed off out of habit.

Chart of DXY Dollar Index Overlaid with Implied 2022 Fed Rate Hikes (Daily)

Chart Created on Tradingview Platform

The Dollar has serious ties to the developments around US fiscal stimulus progress and the government’s deficit status, but this isn’t the only matter that can jerk on the currency’s yoke. Monetary policy is another such active matter, and the outlook received a not insignificant jolt this past session. It was reported Monday that both Eric Rosengren (President of the Boston Fed) and Robert Kaplan (President of the Dallas Fed) would retire imminently amid an outcry in their investment accounts. These are two hawkish voices in the central bank, one of which was due to be a voter next year with the 9-9 forecast of a 2022 hike is clearly contentious. This news could have been a burden for the Dollar and a charge for stimulus-loving assets, but it did not pan out that way. Perhaps it was the relatively ‘hawkish’ remarks from the likes of Chairman Powell, John Williams and Charles Evans around the impending taper that led markets to keep the target on a November announcement.

Perception of Monetary Policy of Major Central Banks

Graph Made by John Kicklighter

Markets to Watch Tuesday

As we move into Tuesday’s trading session, I am certainly watching the Greenback as it seems to be at the center to much of the fundamental risk – both scheduled and otherwise. Fed intent is still a practical driver with FF futures pricing in 22 basis points worth of tightening over the coming year. If Powell, Evans, Bostic and Bollard – some of the scheduled speakers through the day – keep the hawkish momentum going, perhaps the Greenback can muster enough strength to clear resistance. That could be an impressive development for a pair like EURUSD below 1.1650. However, despite the skew in policy and the Dollar’s ability to stand in as a safe haven are meaningful beacons, I still believe a reversal higher remains the path of least resistance. And, if EURUSD clears 1.1750, it would be an inverse head-and-shoulders pattern ‘neckline’ break back into a broader range.

Chart of EURUSD with 200-Day SMA(8-Hour)

Chart Created on Tradingview Platform

Another Dollar pair that has technical and fundamental potential is USDJPY. The pair registered its biggest four-day rally in over six months through Monday and subsequently widened out its smallest 30-day trading range on record. Yet, this break holds relatively limited potential in technical terms to signal intent for return to trend on larger scales. Relative yield has been a difficult line on which to establish trends, but I believe risk trends may be even more frustrated given both currencies are treated as ‘havens’ in these markets.

Chart of USDJPY with 200-Day SMA, 3-Day Rate of Change and 30-Day Range (Daily)

Chart Created on Tradingview Platform

While the scheduled speeches ahead of us seems to place the onus of volatility and momentum upon monetary and fiscal matters, it is important to remember there are other unresolved issues in these markets. Most notably, the trouble around Chinese property developer Evergrande has not been resolved – and only last week, it’s struggle was presumably the prompt for a massive market swoon. It is unlikely the Chinese government allows this company to turn into a contagion risk for the country, but losses could hit foreign investors and/or their lesson to the deeply indebted institutions may get away from them. Then there are also the reports of factors being forced to shutter with varying reasons as to the forced stoppage of work. I will note that natural gas is pushing multi-year highs alongside this development.

Chart of FXI China ETF with Volume Overlaid with Evergrande (Daily)

Chart Created on Tradingview Platform

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