Macro USD Fragility In A Context Of Rising Equities

Narrative In Financial Markets

The overarching theme this week is the dovish turnaround by the FOMC on Wednesday, which has obviously had major knock-on effects in the psyche of the market. To start off, as I show in today’s report, the bear steepener dynamics in the US yield curve is a hint that the market is now pricing in a rate cut as the next move by the Fed, even if far from an immediate outcome.

In the last 24h, the Euro has come under renewed pressure as headlines from ECB’s Weidmann warned us that the German GDP will probably dip well below the 1.5% mark. We had already learned via the German government that they had revised its yearly GDP forecast to ~1%, still, the Euro found a wave of selling-pressure to pare most of its FOMC-induced gains. It’s hard to fathom EUR upside as a function of the merits in the EU economy.

Another major story markets are tracking very closely, even if there are no signs of an immediate resolution, is the US-China trade talks. Pencil in this data folk, March 1st, that’s when the punitive increase of 25% in tariffs to China comes into effect. Since the US aims for a meticulously comprehensive deal with high guarantees of commitment by the Chinese, this is probably a story to still drag on for weeks. Nonetheless, US President Trump said talks are “going well” but a meeting Trump-Xi will still be required.

The next focal points shift towards the European flash CPI data, the US non-farm payrolls, and the US ISM manufacturing PMI. In terms of US data, given the prolonged US shutdown during the month of January, the bar has been set fairly low for today’s figures. If the changes in the 25-delta risk reversals in the options market are any indication, the market suspects a poor showing.

Just be aware, the jobs market is no longer the number 1 driver of Fed policies, so any NFP-led vol should be taken with a bucket of salt, especially in a bear steepener US yield curve. In other words, there are heightened risks of fading a positive read given the macro reset since the FOMC dovish shocker.

Find today’s events below:

Source: Forexfactory

Chart Insights: USD/JPY An Attractive Short Outlook

Looking to engage in USD/JPY shorts as an overall bias looks like a sensible strategy. Vol is due on the US NFP, but spotting potential intraday opportunities make perfect sense as the general market conditions stand.

We have the momentum behind price action and correlated assets converging (DXY, US 30-year bond yield) in the same direction through the 5-DMA. Besides, the options market is pricing Calls in Japanese Yen significantly more expensive than 24h ago heading into the US NFP.

Sell-side action would also play in line with the current market narrative clearly dominated by broad-based USD weakness. The bullish acceleration in the S&P 500 has been capping the downside, but any stabilization in the rate of gains may see the bearish bias resume vigorously.

RORO Model: Risk-On Risk-Off Conditions

The slope of the 5-dma as part of the risk model monitored has gravitated towards an environment characterized by US Dollar weakness as reflected by the acceleration in the US 30Y and the DXY in response to the FOMC dovish outcome from Wednesday. The downward dynamics in the USD are further anchored by the market structure of LL-LH based on Dow theory.

Whenever we are faced with USD-centric movements ruling currencies, we need to seek out the cues off the equity market to gauge the market sentiment. On Thursday, even as the US30Y kept pressing lower to test the 3% handle and the DXY underwent a correction higher (capping gold upside), it was the S&P 500 and its bullish extension that determined the lingering sanguine mood in currencies, resulting in a lower Japanese Yen as US markets got underway, with commodity-linked FX supported.

Yield Curve: Outlook For Growth, Inflation & Policies

United States: The FOMC has represented a watershed moment in the dynamics of the US yield curve, with the market clearly transitioning into a bull steepener phase as depicted by the change in slope in the 5-dma. We are faced with a situation where short-term US yields are dropping faster than the long-term maturities. Whenever this is the case, we have a market sending us a troublesome message towards the US economy. It essentially communicates that economic growth is decelerating in an environment of low inflation. In this scenario, the market is pricing in that the next move by the Central Bank will be a cut in interest rates.

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The Daily Edge is authored by Ivan Delgado, Head of Market Research at Global Prime. The purpose of this content is to provide an assessment of the market conditions. The report takes an in-depth ...

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