The first trading week in October was coinсident to the start of the fourth quarter in 2018. Key events that took place in this past trading week raised a lot of questions to traders and investors worldwide, and it was especially sensitive not only for the bonds and equities market players but also for currency speculators. Several unusual tendencies and divergences have been seen among different sectors in the financial markets, and these factors might have a huge impact on a potential shift in the focus for currency traders. I will try to explain a couple of the observations that I’ve had this week in order to be ready for such changes in the nearest future, and to make money on that, of course.
The fact number one. 10-year bond yields in the U.S. soared to 7-year high levels recently and reached the level of 3.21%. Well, it is not something extraordinary in the scope of the growing American economy, isn’t it? I mean, the economic expansion leads to the tightening cycle in the interest rates by the Federal Reserve, acting in to prevent overheating of the economy. But why do we see such an emotional and dramatic reaction by the market players, especially in the equities sector? Let’s try to figure out step-by-step. What is the mechanism for U.S. Treasuries? What drives the yield? The answer is always related to supply-demand stuff. The yield is determined by the nominal interest rates (set by the regulator), the inflation expectations and the market expectations of changes in these benchmarks.
So, for example, you are an investor who wants to buy a long-term U.S. government debt. Let’s say, you are interested in the 10-year period. You see that the current yield (your income at the end of the agreement) is 3.21% yearly. But at the same time, you predict that the real yield will grow as the Federal Reserve hikes the rates (3 hikes this year, one more hike is expected in December, and two more hikes are pencilled by FOMC for the next year). So, it is in your best interest to wait a couple of months and buy the same amount of government debt (10-year Treasuries), but with more benefit as the yield will grow. The same story happened to the vast majority of bond market players this week. Sellers were at the same level as before, but buyers stayed on hold after the Fed Chairman Powell noticed a possible acceleration in the interest rates hikes due to inflationary risks. Sellers were dominating at the bonds market and the price for Treasuries went down and the yield surged (the price is opposite to the yield).
The fact number two. That situation with the bond yields created a fear in the equities market. U.S. stock plunged 2-3%, finishing the trading week with the worst performance since May 2018, and coming off the recent all-time highs. The main concern was related to a single question: is the economy strong enough to withstand so many interest rate hikes? Traders understand that the increase in the borrowing costs creates an additional pressure on businesses, and that change might slow down the growth in corporate earnings, and the attractiveness of shares could be lower in this case. Add here the bullish speculative growth of the equities’ value, which started to show signs of a bubble, and you will get an average investor who is sitting on the multi-months profit, looking for the best time to take them in the pocket by closing long positions. What do you need to do if you want to close a long position? Right, sell. So, my point is that traders were looking for any reason to get out of the market, and, I think, the market reaction for Powell’s speech was overestimated, as it always happens.
But let’s get back to the currencies. The reason why I wrote so many words about the parallel universe is that markets do not exist in a vacuum. All of the financial sectors are related to each other and the impact of the bonds and equities markets is huge when it comes to the currencies. So, what was the greenback’s behaviour in this environment? It was going up, yes. At least, the U.S. dollar index grew 0.52% on weekly basis, but it went off the weekly high at 96.12, finishing the trading week at 95.60. But the correlation between the U.S. stock indices, the 10-year bond yields and DXY has certain changes. Moreover, the structure of the greenback’s growth compared to its peers was a bit different from the recent periods, and here are my suggestions why.
The daily chart above compares the U.S. dollar index (blue line), S&P 500 (red line) and U.S. Treasury-notes 10-year yields (yellow line). There is an obvious correlation between DXY and US10Y in the period of Spring 2018 when talks about rate hikes from the Fed were dominating in the market. We have a similar situation now when market players discuss faster-than-expected tightening by the Fed and US10Y had an immediate reaction. The stock indices sell-off is nothing but correction, in my opinion, and the things will get back to normal growth in a couple of weeks at least (or even much sooner than that). But why is the greenback pulling down? Why does DXY not react on the huge spike in the 10-year bond yields? I mean rising yields in the U.S. should attract overseas buyers and create an additional demand for dollar assets. The only explanation that I found is that the currency market delays with the same bullish reaction, and we might see much more active greenback bulls this week, when the CPI and PPI reports will be published, as there is an assumption that the inflationary pressure might be accelerated in September.
Another factor that is holding the greenback from a rapid expansion is that the vast majority of investors and currency traders are already long on the dollar index, and they need something much more powerful than Powell’s speech in order to increase the overall volume of long dollar positions. Add here a restructure of the DXY growth: it is going up versus commodity currencies (especially AUD and NZD, the weakest ones among majors), emerging market currencies (there is no demand for high-risk assets in the scope of the worldwide economic slowdown concerns and recent turmoil in Argentina, Turkey and Russia), Swiss franc (which is out of big six in the sense of trading volume after the plunge in 2015) and Euro (EUR/USD is going down, yes, but the bears’ achievements are very limited, to be honest). The British pound is showing first preliminary signs of reversal after multi-months bearish market, the Canadian dollar is hovering around 1.30 level without any significant movement from it.
The only currency which has to decline versus the greenback is supposed to be Japanese yen, and USD/JPY was showing perfect price action in the second half of September, but the bulls’ gains are limited amid recent sell-off in equities. Moreover, my suggestion is that USD/JPY together with EUR/USD, GBP/USD, and, accordingly, EUR/JPY and GBP/JPY should renew the bullish market in the tight correlation to the stock indices, once equities will find the bottom and reverse back North. Any disappointment in U.S. PPI and CPI data this week will ease woes about the 10-year bond yields, and stocks will pick up the bullish momentum again, increasing the worldwide risk appetite.
With that in mind, I am looking at USD/JPY in the scope of long positions in the medium term perspective. I suppose that the recent retracement is deep enough for the healthy correction from the technical point of view. The lowest price on Monday (112.79) exactly fits with 38.2% Fibonacci Retracement level of the bullish price action which started on August 21 (daily chart below). The latest top of the market is also placed around 113.00 level (113.17 to be precise). So it is normal for any asset to come back down to the breached level before making new achievements in the uptrend. The green dotted median magnetic line attracts the bulls, and they would not hesitate to use such a brilliant opportunity to test that line, in my opinion.
The intraday H4 chart below has several confirmations about that suggestion as well. Ichimoku Cloud Indicator with modified settings (13, 34, 55, 34) has completely bullish sentiment, and the support of the lower line of the span also held USD/JPY from the further slide. I expect USD/JPY to trade above 115.00 level (at least the first test with possible pullback) in 5-8 trading days from now (till October 19). Although, the main condition for that is the bullish reversal for equities in the United States (the rest of the world will follow one way or another). I already went long on USD/JPY (aggressively), and I’m ready to add more volume around 112.25/50 in a worth-case scenario.
The fact number one. 10-year bond yields in the U.S. soared to 7-year high levels recently and reached the level of 3.21%. Well, it is not something extraordinary in the scope of the growing American economy, isn’t it? I mean, the economic expansion leads to the tightening cycle in the interest rates by the Federal Reserve, acting in to prevent overheating of the economy. But why do we see such an emotional and dramatic reaction by the market players, especially in the equities sector? Let’s try to figure out step-by-step. What is the mechanism for U.S. Treasuries? What drives the yield? The answer is always related to supply-demand stuff. The yield is determined by the nominal interest rates (set by the regulator), the inflation expectations and the market expectations of changes in these benchmarks.
So, for example, you are an investor who wants to buy a long-term U.S. government debt. Let’s say, you are interested in the 10-year period. You see that the current yield (your income at the end of the agreement) is 3.21% yearly. But at the same time, you predict that the real yield will grow as the Federal Reserve hikes the rates (3 hikes this year, one more hike is expected in December, and two more hikes are pencilled by FOMC for the next year). So, it is in your best interest to wait a couple of months and buy the same amount of government debt (10-year Treasuries), but with more benefit as the yield will grow. The same story happened to the vast majority of bond market players this week. Sellers were at the same level as before, but buyers stayed on hold after the Fed Chairman Powell noticed a possible acceleration in the interest rates hikes due to inflationary risks. Sellers were dominating at the bonds market and the price for Treasuries went down and the yield surged (the price is opposite to the yield).
The fact number two. That situation with the bond yields created a fear in the equities market. U.S. stock plunged 2-3%, finishing the trading week with the worst performance since May 2018, and coming off the recent all-time highs. The main concern was related to a single question: is the economy strong enough to withstand so many interest rate hikes? Traders understand that the increase in the borrowing costs creates an additional pressure on businesses, and that change might slow down the growth in corporate earnings, and the attractiveness of shares could be lower in this case. Add here the bullish speculative growth of the equities’ value, which started to show signs of a bubble, and you will get an average investor who is sitting on the multi-months profit, looking for the best time to take them in the pocket by closing long positions. What do you need to do if you want to close a long position? Right, sell. So, my point is that traders were looking for any reason to get out of the market, and, I think, the market reaction for Powell’s speech was overestimated, as it always happens.
But let’s get back to the currencies. The reason why I wrote so many words about the parallel universe is that markets do not exist in a vacuum. All of the financial sectors are related to each other and the impact of the bonds and equities markets is huge when it comes to the currencies. So, what was the greenback’s behaviour in this environment? It was going up, yes. At least, the U.S. dollar index grew 0.52% on weekly basis, but it went off the weekly high at 96.12, finishing the trading week at 95.60. But the correlation between the U.S. stock indices, the 10-year bond yields and DXY has certain changes. Moreover, the structure of the greenback’s growth compared to its peers was a bit different from the recent periods, and here are my suggestions why.
The daily chart above compares the U.S. dollar index (blue line), S&P 500 (red line) and U.S. Treasury-notes 10-year yields (yellow line). There is an obvious correlation between DXY and US10Y in the period of Spring 2018 when talks about rate hikes from the Fed were dominating in the market. We have a similar situation now when market players discuss faster-than-expected tightening by the Fed and US10Y had an immediate reaction. The stock indices sell-off is nothing but correction, in my opinion, and the things will get back to normal growth in a couple of weeks at least (or even much sooner than that). But why is the greenback pulling down? Why does DXY not react on the huge spike in the 10-year bond yields? I mean rising yields in the U.S. should attract overseas buyers and create an additional demand for dollar assets. The only explanation that I found is that the currency market delays with the same bullish reaction, and we might see much more active greenback bulls this week, when the CPI and PPI reports will be published, as there is an assumption that the inflationary pressure might be accelerated in September.
Another factor that is holding the greenback from a rapid expansion is that the vast majority of investors and currency traders are already long on the dollar index, and they need something much more powerful than Powell’s speech in order to increase the overall volume of long dollar positions. Add here a restructure of the DXY growth: it is going up versus commodity currencies (especially AUD and NZD, the weakest ones among majors), emerging market currencies (there is no demand for high-risk assets in the scope of the worldwide economic slowdown concerns and recent turmoil in Argentina, Turkey and Russia), Swiss franc (which is out of big six in the sense of trading volume after the plunge in 2015) and Euro (EUR/USD is going down, yes, but the bears’ achievements are very limited, to be honest). The British pound is showing first preliminary signs of reversal after multi-months bearish market, the Canadian dollar is hovering around 1.30 level without any significant movement from it.
The only currency which has to decline versus the greenback is supposed to be Japanese yen, and USD/JPY was showing perfect price action in the second half of September, but the bulls’ gains are limited amid recent sell-off in equities. Moreover, my suggestion is that USD/JPY together with EUR/USD, GBP/USD, and, accordingly, EUR/JPY and GBP/JPY should renew the bullish market in the tight correlation to the stock indices, once equities will find the bottom and reverse back North. Any disappointment in U.S. PPI and CPI data this week will ease woes about the 10-year bond yields, and stocks will pick up the bullish momentum again, increasing the worldwide risk appetite.
With that in mind, I am looking at USD/JPY in the scope of long positions in the medium term perspective. I suppose that the recent retracement is deep enough for the healthy correction from the technical point of view. The lowest price on Monday (112.79) exactly fits with 38.2% Fibonacci Retracement level of the bullish price action which started on August 21 (daily chart below). The latest top of the market is also placed around 113.00 level (113.17 to be precise). So it is normal for any asset to come back down to the breached level before making new achievements in the uptrend. The green dotted median magnetic line attracts the bulls, and they would not hesitate to use such a brilliant opportunity to test that line, in my opinion.
The intraday H4 chart below has several confirmations about that suggestion as well. Ichimoku Cloud Indicator with modified settings (13, 34, 55, 34) has completely bullish sentiment, and the support of the lower line of the span also held USD/JPY from the further slide. I expect USD/JPY to trade above 115.00 level (at least the first test with possible pullback) in 5-8 trading days from now (till October 19). Although, the main condition for that is the bullish reversal for equities in the United States (the rest of the world will follow one way or another). I already went long on USD/JPY (aggressively), and I’m ready to add more volume around 112.25/50 in a worth-case scenario.
