Market Commentary

Over the weekend, coming on the heels of the NY attorney general calling for curbs, 60 Minutes ran a feature story focused on high frequency trading (HFT). It features outspoken Wall Street critic and author Michael Lewis and takes a hard look at what’s going in the US stock markets and the implications for investors. It’s well worth a viewing.

There’s a link here to what’s happening in the forex market as well.

The two biggest inter-bank dealing platform names, ICAP (EBS) and Thomson Reuters have both been implementing measures in recent years to achieve exactly the sort of thing IEX in the video looks to do – slow down the HFT shops. Some of the things being implemented along those lines is setting minimum quote life times (how long a quote must be made tradable by others in the market) to cut down on “flash” orders, randomizing the order in which orders are processed, and widening some spreads and/or implementing minimum price moves (it’s been suggested that the move to decimalization in the stock market was the first step toward HFT dominance there).

Unlike the stock market where HFT is said to represent the vast majority of US trading volume, in forex it has not yet crossed the 50% threshold according to recent estimates. It is interesting that the least regulated global market is the one where the big platforms are being proactive about curbing the influence of HFT. Stock markets have been HFT-friendly in the pursuit of volume, in forex the operators are thinking more in terms of fairness and transparency as a way to gain market share. Considering that trading in stocks is more directly linked to consumer welfare than is the case for exchange rates, one would think things would be the other way around.

Who would have thought the “wild west” currency markets would be the ones where the strongest measures are being made by the participants themselves (rather than regulators) to curb abusive practices? If only they’d been a bit more proactive with that pesky fixing manipulation problem!

In my post last week I took up the question of why someone would trade forex, looking a recent online debate of the subject. One of the aspects of said debate was the question of forex market efficiency. Perhaps coincidentally, there’s a new post up on the Liberty Street Economics blog (run by the NY Federal Reserve research group) which takes up the question of efficiency in exchange rates. The following graph is meant to be a visual depiction of that efficiency where EUR/USD is concerned:

Triangular Arbitrage on the Decline

What the chart shows is basically the frequency with which one could find triangular arbitrage opportunities in the market because of bid/ask quote discrepancies between forex dealers. In the early 2000s this was quite common, but that started to decline in the middle part of the decade and now is almost non-existent. The blog author cites increased automated and algorithmic trading in the market as the driving force. It’s hard to make a counter argument. Just looking at the rapid narrowing of spreads across all the major currency pairs backs up the increased efficiency in the markets these days from that perspective.

By the way, this improved efficiency is also a function of the competitiveness of the forex business overall. The estimates suggest high frequency trading in forex remains only a fraction of what is seen in the US equity markets, so it isn’t as big a force on things here. Lots of people piling into the market trying to earn a buck, however, definitely has had an impact. As the business of forex has grown, so has the battle for profits from it. That competition has helped motivate more efficient systems and narrower bid/ask spreads in the pursuit of customer business at all levels.

One of the other points made in the post is that unlike other markets, forex did not see a major efficiency issue during the Financial Crisis. The market continued to operate fairly smoothly. Certainly it was subject to volatility like everything else, but it wasn’t volatility driven by liquidity issues as seen in other places, like the fixed income markets. Certainly we’ve seen nothing like a Flash Crash.

That said, as I mentioned last week, market efficiency isn’t just about mechanical issues such as what the Liberty Street blog post evaluates. It’s also about how participants interpret and act upon in formation – the over/under-reaction question. Yes, forex might be a highly efficient market on a technical basis, but it is subject to psychological inefficiencies like any other.

It’s not been a good last few years for the Chinese stock market. That may be in the process of changing, however.

As the weekly chart of the Shanghai index below shows, the downside momentum has abated considerably in the last year or so. Granted, the market did make a new bear trend low south of 1900 in the middle part of 2013. That was short-lived, though. Essentially, we’ve been looking at a mainly range-bound market since late 2012.

This is actually a potentially significant development for the global markets. To the extent that the Chinese market is an indicator of the health of the global economy, the stabilization of the Shanghai index at least offers a suggestion of potential better times to come. If the market can hold up from falling back below 2000 once more it would be a good indication turnaround potential.

If we think of the stock market as being a forward-looking economic indicator, then we can read some things into these developments in the Chinese market. Stabilization suggests that the worst is likely in the past at this point in terms of economic growth. This is a good thing for China, and for those countries which export to that market.

There is a lot of work to be done before we can declare any kind of turnaround to have actually taken place, though. The double top put in a bit below 2300 is the first major resistance to any potential bullish trend developing. A break clear above there would be a first positive step, but even then we couldn’t get overly positive from a long-term perspective until 2500 gets breached. This is the sort of thing which could take many months, if not multiple years, to actually happen. In other words we probably shouldn’t expect to see a lot of outwardly positive economic indications right away.

Given how narrow the Bollinger Bands have gotten on the weekly chart, there is definitely considerable potential in the Shanghai index. If an upward trend does start to develop (probably indicated in the intermediate term by a break of 2300) there could be some real power to it.

Trade Leader Alex Kazmarck of SpotEuro gives an update on the Euro:

Emerging markets have shaken things up quite a bit over the last few days. The EM currencies have been sliding and Central Banks stepped in to support their currencies by raising interest rates to fight capital outflows. This activity has been blamed on the US Federal Reserve and its quantitative easing activity and its recently begun tapering program as investor expectations have shifted from a slowing China to a growing US.

Euro Update and Outlook

With liquidity in the euro-zone financial system drying up as the banks have paid back the emergency LTRO loans from 2011 and 2012, euro area CPI remaining below 1% and most notably Germany’s CPI m/m coming in at a -0.6% vs. -0.4% estimated today, the euro is beginning to feel the pressure and has recently continued what seems to be as the next major leg to the downside against the US Dollar. European Central Bank President Mario Draghi has signaled that he is ready to act if needed and with this macro backdrop occurring in the emerging markets and the recent equity sell-off, he will most likely act sooner rather than later, further putting pressure on the euro.

As mentioned in my last analysis of the euro, the uptrend from July of 2013 has been broken to the downside following the December ECB meeting. The 1.3500 level is now under pressure and once broken, the next level of support will be 1.3300 and 1.3200, which correspond to the 50% and 62% retracement levels from the July-December 2013 highs. Other technical indicators are pointing to a continuation to the downside but the price action and correlation in other markets (equity, USD index, and gold/silver) are confirming that investors have turned on their ‘risk-off’ investment mentality and will now seek safer alternatives during this time of market correction, which has been spoken about for a long time. There are only a few things that may alter the current course and the Fed pausing its tapering program if economic data disappoints during the next few weeks will be the main catalyst for a potential reversal. Resistance is now between 1.3700 and 1.3730, last weeks’ highs and the 1.3800 level will need to be broken in order to have bullish continuation. At current levels, the risk/reward is favored toward the downside and I suspect momentum picking up.

Technicals

All daily techs are sliding. MACD has turned negative and is now looking to cross to continue a move lower; RSI has broken below 50 again and is picking up speed; the ‘trend’ oscillator has just crossed lower; notably, the pair trading below the 50 and 100 day EMA with the latter beginning to smooth out and turn lower over the next few days. The 200 day SMA is now at 1.3375 and will most likely be at 1.3400 by the time price reaches that level. At that point I will look for consolidation prior to a break lower.

My thoughts.

Volatility is sure to pick up and I would not suspect the downwards movement to be without any pullbacks. As I continue to see a dollar rally across the board, JPY aside, I am looking to enter on support breaks and pullbacks, while looking for ECB and FOMC guidance to drive the longer term direction. Risk-off price action should continue to drive the markets in the near-term and capitulation may occur given the right sequence of events. Buying the euro on dips could be a dangerous strategy which I will be sure to avoid as the problems that plagued the euro area in 2012 and 2013 could soon return.

Short term resistance – 1.3700-1.3800

Short term support – 1.3500

Looking for momentum to pick up on a break of 1.3500

Recap

The GBP/USD pair has had quite a steady move higher since the summer of 2013, after bottoming out at 1.4840 for the second time in 4 months. Since then, the pair has managed a 12.1% increase in price in the span of 6 months. Consolidation occurred between late September and November before continuing higher to recent two and a half year highs. Over the past few weeks the pair has managed to find resistance just under the 5 year high of 1.70, topping out at 1.66 beginning in early January. The current price action points to a correction, with momentum in favor of the dollar.

In this analysis I will only cover technical points to consider for both short and long positions along with fundamental catalysts that could alter the current trend higher.

Technical Analysis

The first point I’d like to bring to your attention is the big move that occurred during the fall of 2008, when the pound dropped from 2.01 to 1.40 during the highs of the financial crisis. The price action we’ve seen since quantitative easing began later that year was a corrective one, with a 50% retracement at 1.6830 acting as resistance for the last 4 years. During this time, it looked to have traded in a wedge (marked in orange) before what seemed to be like a breakout lower that eventually double bottomed at the 1.4850 level. What made this move believable was that the initial break of the lower wedge support retraced to the 62% level before another sharp move lower broke the previous pivot low; however, it was not able to close below the pivot low and from that moment the pound began its 12% rise.

Looking closer at the pounds recent strength, we can see the rise taking place in a channel, which is currently being tested at the support. Previous level of resistance, which acted as support in December, is just under 1.6300, which I think will be important if the channel is broken. If we see a daily close below 1.6200, then I suspect a retracement is in full gear and my target for a short would be somewhere between 1.57 and 1.58, which is just above the 50% fib level of the channel. This retracement should continue to be valid until the January high of 1.66 is broken.

The longer term analysis seems to point for further sterling strength, unless there is a fundamental shift in UK housing, inflation, or economic data that acts as a catalyst for a reversal. Pound strength is also technically supported by the strong reversal following the break of the wedge, and the recent strength that resulted in the 12% appreciation of the pound thereafter. Once 1.66 is broken I expect 1.70 and 1.76 to come into the picture with the earlier being resistance during 2009 and the latter being 62% retracement of the financial crisis.

Outlook

While the longer term trend says long, the shorter term analysis is pointing to a correction in favor of the dollar. I’m looking for this week’s economic data to be the driver of price action with technical support/resistance levels acting as inflection points. The 1.66 resistance must be broken, and I prefer to see a close above the figure, before I consider a long and continuation of the uptrend.

A close below 1.6300 would result in the current uptrend being broken and I will look for 1.6200 as support before a close below will confirm a correction with a target of no less than 1.6000 with continuation to the 1.58 level. This could also be the beginning of a head and shoulders formation.

Summary

The correction could begin when UK and US inflation figures are released this week (Tuesday/Wed & Thurs) or on economic weakness such as US and UK Retail Sales (Tuesday/Friday). Mark Carney is also scheduled to speak on Wednesday. A lot of potential catalysts; I expect volatility and some of the prior mentioned levels being seen as early as Tuesday.

Short term resistance – 1.6500-1.6600

Short term support – 1.6200-1.6300

The new year is fully in swing now, and there are some interesting things brewing with the US dollar. As you can see on the daily chart below, the USD Index has been mainly consolidating for the last few weeks after falling out of an earlier range back near the start of December. The recent action, however, has seen the market push up through the top of that area. This comes as the relatively narrow Bollinger Bands have begun widening out once more. That is usually a good indication of a new directional move starting to develop.

There’s a fair bit of resistance overhead for the index to overcome, of course. Prior rally failures near 81.00, 81.40, and 81.50 all point to the potential for the bulls to struggle to generate serious momentum.

There’s a bit of a added factor supporting the greenback here, though. The first part of the year is generally a strong one for the dollar (see this forex seasonals research). That is something which could give the USD Index a nice tail wind in the days and weeks to come.

If the season factors do indeed help drive a new uptrend, the real test would be around  the 82.50 area. That’s a key price zone in the weekly timeframe. The reaction to testing it would tell us a lot about the longer-term prospects for the dollar moving forward as in that time frame we’re also seeing the sort of narrow Bollingers which often preceeds a new trend.

Currensee Trade Leader Alex Kazmarck of SpotEuro LLC presents predictions for 2014... and things are already moving faster than anticipated...

I expect trading ranges into the New Year and the first few days of the new calendar year since most activity will being on the 6th of January since the 2nd and 3rd fall on a Thursday and Friday, not likely to be market movers without some significant catalyst.

Going into 2014, I think traders will continue to debate the US monetary policy and how new Federal Reserve Chairwoman Janet Yellen will manage the QE exit, or perhaps even stay the course (now known as the “new normal”), continuing to support the US economy if data begins to show signs of weakness. Traders will also look closely at growth in both US and Europe, with the latter being a focus of peripheral growth outside of Germany. It’s important to add that economic divergence in Europe will also put pressure on politics as well as the ECB, possibly calling for a weaker euro or a change to ECB’s mandate. Finally, Japan will also be in focus as the BOJ’s 2% inflation target may be difficult to reach and with a looming increase in sales tax from 5% to 8%, some members of the board have expressed concern in the Q3 GDP growth figures. How will the BOJ attempt to reach its inflation target without hampering growth? These are the stories that will likely drive price action during the next 12 months.

Technical Analysis

In the next few weeks, as everyone gets back to their desks and volumes begin to pick up, there are certain levels that I will be monitoring for directional purposes. Taking a look at the EUR/USD, the pair has maintained an upwards trending channel; however, it was not able to break above the 1.3820 high set in late October just before ECB surprised the market with a reduction in the benchmark interest rate. Despite the rally that followed in November and early December, I am still looking for a move lower to 1.3500 before continuing lower to the 1.30s. This view will be negated if the pair breaks higher and closes above the 1.3800 level. To the downside, this view is supported on a close below 1.3600 with next support at 1.3500 and 1.3400. A close below 1.2750 should begin a new down trend.

On the other hand, should the pair close decisively above 1.3800, I will target 1.4250 and 1.4500 as levels of resistance where the pair will likely consolidate. I don’t see much support for this view as Europe continues to lag the US in economic growth and monetary tightening. I will also point out that the current top of 1.3833 is also the 61.8% retracement from 1.4920 high in May of 2011 to the low of 1.2043 set in July of 2012.

I expect the euro to end 2014 between 1.2500 and 1.2800 with 1.20 and 1.38 as the low and high respectively.

Summary

Keeping in line with the “new normal”, I find it difficult to believe that the US economy will be able to sustain such growth in both the labor and financial markets in 2014 as it had during 2013 without continued pressure to keep yields low with its current QE purchases and force money into riskier assets. Inflation will be an important figure to watch, especially if the Fed decides to lower interest on excess reserves below zero as this should fuel banks to lend more, fueling consumption. The themes that made headlines in 2013 will continue to be the front runners in 2014 and should be followed closely.

Short term resistance – 1.3750-1.3800

Short term support – 1.3650-1.3600

It’s been a while since Crude Oil was a topic of conversation here, so I thought I’d circle back around to it and see what’s happening. Effectively, there hasn’t been much in the way of net direction for black gold in quite a while. The market has been ranging either side of about 100 for the last couple of years. That has not, however, kept there from being some quite sharp moves, as the weekly chart below shows. (click to enlarge)

In fact, we’ve just seen a rather sharp drop in crude prices taking them from their most recent highs near 112 to a low around 92 in just a couple months. The question in mind right now is whether that downtrend is likely to continue.

There are two key things which may provide some indication. First, the market’s decline reached just about the midpoint of the Q3 2012 – Q2 2013 range. That is a natural attraction area, so it’s no surprise we saw the market get there once 100 was broken to the downside. The second is the reaction thus far to the market trying to get back toward 100. That rally stalled out fairly abruptly.

Being back in that old range sets the market up for a period of consolidation. My feeling, though, is that we’ll eventually see a continuation lower – perhaps to test the 85 area once more. There was a lot of downside momentum in the recent sell-off and I don’t think it’s all gone yet. If the market cannot fairly soon get above 100 and sustain itself there, I think the sellers (or lack of buyers) will eventually see another leg lower.

Alex Kazmarck of Trade Leader SpotEuro presents analysis of the GBP/USD.

Technical Analysis

The weekly GBP/USD chart shows a very long consolidation pattern in the form of a triangle following the big drop during the 2008 crisis. Once the bottom formed near 1.3500 a retracement began to take shape, finding a top just under the 1.6800 level, which can be noted as the 50% retracement level. This triangle continued to consolidate for the next three years until the first quarter of 2013 when it was broken to the downside; however, the move to the downside lost traction mainly due to the dollar and the risk-on environment. There was a double bottom in mid-2013 before the sterling began to rally back towards the upper end of its previous four year range.

Looking at the daily chart, focusing on the July impulsive movement that created a new low during 2013 but was unable to close below the figure, I think many are surprised at the resilience the pound has shown during the last few months. Most of the move can be attributed to a weaker dollar (USD Index) along with supporting evidence of stronger economic growth within the UK; however, I think it’s too early to call this a new trend until we see a clear break above the earlier mentioned 50% retracement.

Once the pair closes above 1.68, it should get a positive boost from a technical perspective and it will be “open water” all the way to 1.76, the 62% retracement on the weekly chart.  If this occurs, the analysis would have lost much of short term bearish potential I’m looking for.

While I’m not calling for any specific direction at this time, I’d like to note that the false breakout to the downside has also created a possible head and shoulders formation with the orange box representing the left shoulder and the current rally representing the “head” of the formation. It’s also interesting to point out the rising trend-line from the triangle acting as resistance.  Having said that, there is also an inverted head and shoulders formation with the double bottom representing the head and the 1.5850 level representing the neck-line as can be seen on the daily chart.

Summary/Outlook

Technically, this setup can play out in several different ways and I am placing more emphasis on the USD than on the GBP. While technically this pair has rallied quite nicely following the false break and double bottom, I am reluctant to take a long at these levels and would prefer to short the pair into a possible risk-off scenario going into the December FOMC announcement. I’m keeping an eye on the daily trend-line and a close below 1.5800 should support the bears. Once the pair closes below the 1.4900 level, the pair should continue to gain momentum and a possible retest of 1.43 and 1.36 will be targeted. Perhaps we’ll continue to see more range-bound activity with increased volatility.

Short term support – 1.6300 to 1.5850

Short term resistance – 1.6500 to 1.6800

With the final FOMC meeting of 2013 nearly upon us, there is predictably a lot of discussion and prediction regarding whether the Fed will in fact finally begin its long-awaited taper. As note in this article, Chairman Bernanke back in June indicated an expectation that we’d see the central bank starting to back down its quantitative easy efforts by year’s end. Many in the market expected to see it begin in September, which obviously didn’t come to pass.

Even now there is disagreement as to whether the Fed members are leaning toward starting the taper before 2014 or not. As this Zero Hedge post notes, the Wall Street Journal and New York Times are reading the tea leaves in different ways, with one saying a December move looks likely after the jobs report last week and the other saying the FOMC is still likely to hold off.

So what do the markets say?

Well, first of all we have the reversal of the spike up in 10yr Note yields seen on Friday after the jobs data was released. This shows up as a potential rejection high on the daily chart, which isn’t the most positive of developments.

It should be noted, though, that while the market did quickly reverse the move above 2.90%, it did so only to then stabilized back in the area between about 2.85% and 2.88%. Basically, there was a kneejerk reaction – no doubt helped by the algos – and then the markets settled back. This is an indication that traders probably had the data priced in fairly well. That leads us to look at the longer-term view.

Back at the start of November I wrote about yields finding support just above 2.40% and the prospects some saw of a head-and-shoulders top pattern forming on the weekly chart. We have since seen a strong rally off that support, which has served to further narrow the Bollinger Bands. This is setting the stage for a potentially very sharp move in the months to come. On need only look at what happened the last couple years when the Bands were comparably narrow.

The question is which direction the move will eventually go. I think the rally we’ve seen tends to take the head-and-shoulders top out of play – though maybe there could still be a double-top type development. To my mind we’re in a continuation pattern which suggests an eventual uptrend continuation. This tends to be supported by the improving US economy and eventually will be further supported by the Fed reducing its purchases of Treasury securities. Certainly we’re close enough to the top of the Band range that an FOMC taper announcement – or perhaps even just an indication of it being pending - could be the catalyst to launch a new leg higher.