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EURUSD Eyes Reversal After Stall, S&P 500 Quiet Will be Fleeting with Thinned Liquidity

EURUSD Eyes Reversal After Stall, S&P 500 Quiet Will be Fleeting with Thinned Liquidity

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S&P 500, Nasdaq 100 Futures, Peloton and EURUSD Talking Points

  • The Trade Perspective: QQQ bearish below 350 and EURUSD bearish below 1.1400
  • The Nasdaq 100 and S&P 500 have opened the week to a technical ‘inside day’, which is a high break risk given the thinned liquidity conditions registered in futures liquidity
  • Rate expectations remain a top fundamental theme, but the pace of European yields represents a more acute reversal risk…which makes EURUSD much more interesting

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Risk Assets Finally Settling? Not So Fast

Compared to the past few weeks of exceptional volatility, this trading period has opened to relative calm. Considering the material downgrade in the economic docket over the week ahead, that seems fitting given the circumstances. That said, assuming quiet and tight market ranges is a risky proposition given the backdrop of conditions that we are dealing with – particularly shallow liquidity and a market sensitivity to global interest rate expectations. When it comes to a speculative benchmark like the S&P 500, I consider Monday’s ‘inside day’ (whereby the recent day’s range fits neatly within the previous session’s) a staging for a break. The scope for movement is not large, so the question naturally shifts to a consideration of how far the markets will run when we clear the 4,550 / 4,450 congestion. I believe a resolution to the downside would generate more traction as it leans against the complacency view that has defined the bullish bearing. Below, the sharp drop in short-term (3-day) volatility relative to medium-term (20-day) volatility visualizes the market’s remaining on edge rather than comfortably complacent.

Chart of S&P 500 with 100 and 200-Day SMAs, 20-Day ATR and 3 to 20 Day ATR Ratio (Daily)

Chart Created on Tradingview Platform

Why are markets so prone to volatility and more pointedly at risk of a steeper reversal than extension of the bullish trend? Fundamental issues like a plateau in growth forecasts, geopolitical tensions and a swell in interest rate expectations certainly pressurize the investors’ backdrop. However, there is something more fundamentally unnerving for the speculative masses: liquidity. I’ve mentioned before that with markets at such extremes and deviating from traditional valuation metrics that there is more participation by speculative traders rather than traditional investors. That has a material impact on how the financial system operates. Rather than deep pocketed market participants building up exposure with an investment horizon over years and wider stop losses, we are seeing a greater influence from the short-term, dip buyer that has no intention of carrying the market on their shoulder alone into new territory at record highs. To give a sense of this participation, we can look to the more liquid benchmarks of ‘the market’. S&P 500 emini futures show the issue at hand with open interest dropping to levels not seen since mid-2007.

Chart of S&P 500 Emini Futures with Open Interest (Daily)

Chart Created by John Kicklighter with Data from Bloomberg Terminal

An argument can be made that the S&P 500 has been deprecated in favor of the Nasdaq 100 for its more concentrated ‘disruptive’ appeal for the tech giants. That may be the case to some extent over the past few years, but we have seen the tech favorite index take a bigger hit over the past few months than its broader peer. For the ‘growth to value’ measure of the Nasdaq 100 to Dow ratio, we edged a little lower to start this new week – though not materially enough to extend the reversal from the Dot-com boom/bust record high hit three months ago. On the liquidity line, consider the level of turnover behind the Nasdaq futures relative to the market’s open interest. We have seen the average (20-day) of volume jump to three times the volume of open interest regularly the past two years. That is the definition of an at-risk market and unusual for these typically, deeply-liquid benchmarks.

Chart of Nasdaq 100 Futures Overlaid with 20-Daily Avg Relative to Open Interest (Daily)

Chart Created by John Kicklighter with Data from Bloomberg Terminal

The Traditional Fundamental Considerations

If you are looking for what can shift gears on the market from congestion to break and meaningful follow through in the coming session(s), it is worthwhile to keep track of the so-called ‘traditional fundamental’ events. On the economic calendar, I will be watching the US and Canadian trade balance figures which can reflect directly on USDCAD and amplify the news this past session that the US is planning to drop tariffs on Japanese steel imports – a reversal of Trump era trade war policy. I will also keep close tabs on the US business sentiment survey (NFIB), economic sentiment survey (IBD) and the fourth quarter household debt and credit report. However, for a more pointed fundamental reflection, I will be keeping tabs on the after-hours earnings release from Peloton and Lyft. These are far from the mega market caps of the FAANG members last week, but they are a very poignant pairing when gauging those companies that did better during Covid lockdown versus those that benefit the reopening. With confirmed covid cases easing from the omicron outbreak, will the ride share continue to outpace the at-home exercise company? Of course, if acquisition rumors for PTON pan out, this equation will change significantly.

Chart of Lyft-Peloton Ratio Overlaid with Worldwide Covid Cases and 7-Day ROC Inverted (Daily)

Chart Created on Tradingview Platform

The Persistent Fundamental Driver

While there are ‘alternative’ fundamental matters which can override our attention moving forward, the status quo would likely keep monetary policy forecasting as the principal driver everything being equal. These past few weeks, we have seen the rate forecasts for the major central banks soar as inflation pressures have forced policy makers to back out of their ‘transitory’ position. That said, the forecasts have hit frankly outlandish levels. Is it possible that the Fed hikes six times, the Bank of England another five times and the RBNZ seven times in 2022? Sure, it is possible. However, if these authorities are pushed to be this hawkish, the implications for risk appetite in capital markets are dire; and a full risk aversion is likely to cut down rate forecasts. Therefore, I’m keeping a close tab on two-year government bond yields on these majors. Should they fall back individually, there is likely to be relative value potential. If they all retreat, it is a ‘risk’ implication.

Relative Monetary Policy Standing of Major Central Banks

Chart Created by John Kicklighter with Data from Swaps

Speaking of rate forecasts, I think there is something to be said about those forecasts that have seen a sudden shift in trajectory. While the forecasts for the US and UK have climbed substantially, they have done so over the span of months. That is not the case with the rates for the Eurozone. The German 2-year yield in just the past week surged 39 basis points to from -0.60 to -0.21 percent. That is a very abrupt move helped along by speculation surrounding last week’s ECB rate decision. So while I consider the US rate outlook to be seriously stretched, it isn’t nearly as extreme relative to its European counterparts. I’ll be watching how this relationship pairs up with EURUSD, considering that the correlation has been very strong as of late. If the GE-US spread continues to weaken and the pair slips 1.1400, it would be a fundamental and technical confluence to watch closely.

EUR/USD Bearish
Data provided by
of clients are net long. of clients are net short.
Change in Longs Shorts OI
Daily 19% -7% 3%
Weekly 4% -7% -2%
What does it mean for price action?
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Chart of EURUSD with 100 and 200-Day SMA Overlaid with German-US 2-Year Spread (Daily)

Chart Created on Tradingview Platform

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