Forex FOREX PRO WEEKLY, January 02 - 06, 2023

Sive Morten

Special Consultant to the FPA
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Fundamentals

Despite that we're starting the new year, guys, there are not too many things to discuss as market remains quiet in "dead" season between Christmas and New Year's Day. Just few statistics data have been updated. Still there are few things that become more evident as crisis starts showing its "structural" background, not cyclical. While 2022 year has passed under the sign of the struggle against inflation, the 2023 prepares new challenges, that seem more difficult to resolve. Everybody knows that to defeat inflation you have to rise rates (at least its monetary component) but what to do now with negative events in construction, big skew in corporate finances, all time high public consumer loans and breaking of the balance in interest rates structure (between Fed and commercial banks) inside the US - are just a few questions that yet to be answered. And not only answered but somehow demand the solution as it directly impacts the economy.

Market overview

There are few events are worthy to mention this week. First is European Central Bank President Christine Lagarde indicated borrowing costs will increase again, saying this is required to temper soaring consumer-price growth. The ECB raised interest rates by 250 basis-points this year and policymakers including Lagarde have said more hikes are to come, with markets and economists expecting half-point steps at the next two meetings. She also highlighted the ECB’s ever-watchful eye on inflation.

“At the moment, ECB policy rates must be higher to curb inflation and bring it down to our target of 2%,” Lagarde told Croatian newspaper Jutarnji list. “That process is essential because it would be even worse if we allowed inflation to become entrenched in the economy.” “We must not allow inflationary expectations to become de-anchored or wages to have an inflationary effect,” Lagarde said. “We know wages are increasing, probably at a faster pace than expected, but we must be wary that they do not start fueling inflation.”
While such rate aggression comes just as an economic downturn takes hold in the region, the ECB president highlighted that the “recession we feared is likely to be short-lived and shallow,” citing her institution’s most recent forecasts.

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At the same time, ECB is cutting liquidity with the record tempo. The ECB's balance sheet has shrunk by almost 800 billion euros in 5 weeks. In the week to November 25, the reduction in the balance sheet amounted to 298 billion euros, and in the week to December 23, the balance shrank by a record 491 billion euros.

The entire reduction in the balance sheet is due to the repayment of loans taken by the Eurozone banking system during the pandemic and aggressive lockdowns. Holding of these loans has become unprofitable for banks. There is no sense in paying 2.5% on excess 1.6 trillion euros, which are not used in the real economy.
The tension in the debt markets increases again at the end of the year – rates are rising, liquidity is less and less, the lack of confidence is more and more obvious.

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Second important issue that is worthy to mention is Initial claims changing. But we're mostly watching for continues claims. Although employment data is strongly manipulated, and numbers per se are not important, but tendency is the one that we have to pay attention to. Last week of 2022 has not become a surprise either.

The Labor Department found that the number of people receiving benefits after an initial week of aid rose to 1.710 million in the week ending Dec. 17. Those so-called continuing claims, a proxy for hiring, have drifted higher since early October.

"Historically, when you have that pace of increasing continuing claims, it's been an early signal of a downturn," said Steve Englander, head of G10 FX research at Standard Chartered.

United States Continuing Jobless Claims
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Another important indicator is a length of work week. It keeps dropping which also suggests sign of recession. Currently it is a bit skewed by holidays, but in Jan-Feb there should be more realistic data.

Also it is worth to mention interesting tendency that looks absolutely contradictive. While it was reported positive GDP and even upside revision of IIIQ numbers, we have drop of companies' revenues on a background of inflation. This is bad combination. As we've shown few times, inflation supposedly is higher than it was reported around 6.5-7%. GDP is mostly book keeping term that could be "slightly adjusted" when needed. With this background we see that as Service companies as manufacturing ones are loosing revenue. With adjustment to inflation the real decrease of revenues is probably higher.
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The Fed does the same as ECB - dries liquidity with high tempo. The real money supply in the United States is shrinking at a record pace in history – minus 6.6% YoY compared to the previous anti-record in April 1980 (minus 6.5%) But it is still very far from the complete disposal of the excess money supply formed during the period of monetary and fiscal madness of 2020-2021. Compression should occur for another 13-14%

The deviation of the real money supply from the trend of 2010-2019 by September 2021 was over 25%, the money supply has been declining in real terms for the last year. There are two recycling mechanisms – inflation and forced withdrawal of money supply from the economy/financial system. Now the first mechanism is mainly operating. It is important to note that there is a de-synchronization of expenditures of the population and the money supply in real terms. Usually, with a decrease in M2, expenses also fall (according to the experience of the inflation crisis of the 70s-80s), but now this is not happening.

The out-of-sync is due to record lending rates of the population and record low savings rate as an attempt to compensate for falling incomes and inflationary absorption. However, there is a very limited margin of safety of such a compensation mechanism.

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Indeed, as we've shown last time, Fed has limited margin of safety, and already has spent ~ 50% of US Treasury reserves on markets' support since October 2022. They has approximately $350 Bln more that should be enough until March-April, but then the inflation rate will become the hot topic. If 5-5.25% rate doesn't hold inflation but reserves will be spent already, this could force them to turn back to easing again. And big banks already build plans on how and when this should happen. There will be no problems if inflation drops at least to 3-3.5% but what if remains at current levels? We sure with 90% that it remains high. Just because we're in structural crisis, it is not cyclical.

US interest-rate strategists mostly expect that Treasuries will extend their recent rally, dragging yields lower and steepening the curve in the second half of 2023 so long as labor market conditions soften and inflation ebbs. The most bullish forecasts among those published by primary dealer firms — including predictions from Citigroup Inc., Deutsche Bank AG and TD Securities — anticipate that the Federal Reserve will cut its overnight benchmark in 2024. Goldman Sachs Group Inc., which predicts that inflation will stay unacceptably high and that the US economy will avoid a deep recession, has the most bearish forecast.

In addition to the outlook for policy and inflation, expectations about Treasury supply are a key factor shaping forecasts. The supply of new US debt shrank in 2022 but could resume growing if the Fed continues to shed its holdings. Here we mostly should keep an eye on 2-year yield because it better reflects Fed fund rate dynamic.
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Every bank gives some comments to forecast, you could read it by link above. The most common comments Citi gives:

Assumes fed funds rate will peak at 5.25%-5.5% and market will price in cuts totaling 275bp from December 2023 to December 2024

JP Morgan suggests that -
Yields should fall and the long end should steepen once the Fed goes on hold, consistent with previous cycles,” expected in March at 4.75%-5%. Demand dynamics could remain challenging,” however, as QT continues, foreign demand reflects muted reserve accumulation and unattractive valuations, and commercial banks experience modest deposit growth; pension and mutual demand should improve but not enough to fill the gap.
But, some banks (RBC Capital) even suggest that 50 bp rate cut could happen as early as in II H of 2023. So, the major question is what inflation will be at the moment when Fed reserves exhaust. Some analysts also worry about it, and this is our opinion either.

“The bond market is expecting inflation will pretty neatly come back into zone in 12 months,” said Matthew McLennan, co-head of the global value team at First Eagle Investment Management. But that may be a big mistake. There is a real risk that wages growth and supply-side pressures like elevated energy costs keep fueling consumer price gains, he said. This would rule out the pivot to cuts from the Federal Reserve and European Central Bank that markets see coming in the middle of the year.

Then there’s the question of higher borrowing costs triggering a recession and how that plays out for investors, according to McLennan. “The Fed didn’t see inflation coming and in their quest to fight inflation may not see a financial accident coming,” he said. “It’s quite possible the Fed is underestimating the risk of financial catastrophe.”

In general, the appetite for the dollar was also helped by haven flows, among other factors, as concern about the tightening of global policy weighed on riskier assets along with heightened geopolitical tensions and ongoing concerns around Covid. The possibility of a US recession, risks around China’s Covid reopening, and the possibility of further declines in stocks, of course, have the potential to re-invigorate the appeal of the US currency at some point. For now though, the trend is down, and all eyes will be on how the economic and market landscape plays out in early 2023.

“The reasons to sell the dollar are mostly generated by a sense of optimism that the world is healing,” Societe Generale SA strategist Kit Juckes wrote in a note to clients, pointing to developments around issues ranging from China’s reopening through to inflation. But he also warned that if investors think markets are being too complacent, they “should be wary of hangovers and euro softness in January.”

Conclusion

So, let's call it a day, to not bother you too much on Holidays. In general, we could say that negative processes in the global economy are developing evenly and consistently, almost without paying attention to calendar features. This does not correspond to the logic of cyclical crises, which usually accelerate first, and slow down to a minimum second.

We consider it important to recall this once again, since any public references to the crisis (which is called exclusively a "recession") appeal precisely to its cyclical nature. This inevitably affects everyone who is forced to make decisions related to the economy, from entrepreneurs to officials, and greatly disorienting these people.
In this regard, we remind you once again: the current crisis is of a structural nature. This determines its features and duration, and understanding this gives a very serious advantage, both competitive and intellectual, to those who have figured out the situation

We rare take a look at something outside of the US and EU, but to show you the global nature of this crisis, take a look at some data of Asia Pacific countries:
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In general you could continue this sequence and take a look at performance of other countries, such as Australia by yourself - you will see more or less the same picture across the Globe. The same is about Real Estate market. For example - How UK House Prices Could Fall by 30% or Euro zone business lending growth slows sharply in November.

Officials in almost all countries are showing optimism. The reality, as we can see, is different a bit — the structural crisis continues evenly and inexorably, as it should according to theory. Entrepreneurs already feel something is wrong, but households are also beginning to realize that things are not going well. In any case, the University of Michigan shows record dissatisfaction with the situation:
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Life expectancy is dropping either:
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Of course we could accuse the Covid -19. But even indirect indicators demonstrate that the situation in the United States (and therefore around the world) is far from optimal. Actually, we show you these graphs to show that, albeit slowly developing, the structural crisis has an extremely negative impact on all components of human life.

It should be noted that the structural crisis can show itself in completely different spheres. So, from September 2021 to June 2022, inflation grew in the United States. But as soon as they began to fight it seriously, industry, construction and retail sales began to fall. Now the US monetary authorities believe that a drop in household demand (that is, in fact, a drop in GDP) is not as dangerous as an overheated economy (high inflation). They do not understand that their target to put inflation down to the required 2% will most likely fail, since the structural component does not respond to the tightening of monetary policy.

Thus, if we continue to fight inflation by tightening monetary policy, then inflation will not fall to the required values, and economic indicators will actively deteriorate. And if this deterioration frightens the political authorities and they begin to maintain the standard of living of the population, then the economic pendulum will swing in the other direction, inflation will begin to rise again, the crisis will begin a new round. In fact, with the anticipation by big banks of Fed easing leads us to this conclusion. Although as Fed as big banks suggest that inflation should decrease by this moment, and this is major difference to our view. In the new 2023 year we will see how events will develop.

Concerning EUR - we suggest that this is temporal growth as EU is an absolute loser of 2022, together with Ukraine and Russia, while major winners are US and China. EUR rate change is going to be faster in Feb and March with two of 0.5% change, while Fed supposedly will change rate for 0.5 and 0.25% correspondingly. But, as this was evidently said, mostly the new balance is priced in. Closer to the end of the IQ 2023 problems start grow as a snowball and could become a real headache for the ECB. Europe could get fruits of tightening earlier than market suggests.
 
Technicals
Monthly

So, the major event of last week is loosing of the bearish grabber on the monthly chart. Market has closed above 1.0623 level and December has not become a grabber. EUR shows high close in December, challenging monthly K-resistance area and completing minimum upside reaction to butterfly pattern.

It means that B&B "Sell" start postpones. Maybe EUR is coming to its favorite 50% resistance around 1.1050? This level also is monthly Oversold and long-term trend line (somehow guys I can't attach chart so you could watch it by links):

EUR/USD Monthly chart

Weekly

Here we do not have any big changes. Trend remains bullish, as well as the whole context. Recent two weeks were inside ones and make no impact. Overbought stands around 1.0920 area. Market now stands at K-resistance area that suggests some downside pullback and tells us to not take any long positions right here:

EUR/USD Weekly chart

Daily

Here we've warned that bullish signs are growing and EUR are getting clear shape of bullish dynamic pressure. On Dollar Index Friday performance looks even brighter:

DXY Daily chart

Our triangle has been broken down and market is challenging the lows. It means that as 3-Drive "buy" as the grabber both stand at the edge of failure. So, our suggestion of "no shorts" is confirmed.

Intraday

Dollar index picture makes it obvious to suggest upside butterfly on EUR, with two targets - 1.0780 and 1.0835. Both do not contradict weekly overbought, but stand above monthly K-area, at least the latter one. Thus, hardly we get any bearish signs until at least 1.0780 target will be reached.

EUR/USD 4H chart

Although we can't go long on weekly chart due resistance level, it is possible to consider on 1H chart for short-term trading. With the clear shape of the butterfly on the back and upside breakout of the trading range that we were considering here through the week, it is possible to consider 1.0670 and 1.0650-1.0660 K-support area for position taking. Market has completed AB-CD target, CD leg shows acceleration that increases chances on challenging the top. So, if you would like to, you could try to use butterfly context for short-term position taking and mentioned targets.

EUR/USD 1H chart
 
Morning everybody,

Dollar index has not traded yesterday, so we have minimal changes on other currencies as well. As we've agreed - we postpone short entry until clear bearish signs will be formed. Right now, despite minor pullback on EUR, it still could climb higher by two reasons. First is, yesterday was solid rally on Gold market, second - JPY is moving down, following our pattern. Thus both assets suggest some weakness in the USD.

EUR daily chart

On 4H chart we were considering butterfly pattern, with 1.0740 target. Depending on the depth of the retracement down, butterfly could change the shape and become larger. Although target will not change:

EUR 4H chart

On 1H chart market accurately completes our plan, dropping back to strong support area. Depending on EUR performance here, we either will get larger 4H butterfly shape or not. Based on performance of JPY and Gold, chances of deeper action look significant.

EUR 1H chart

So, as we've agreed, we stay aside with bearish positions by far. For scalp long position I would consider only two ways. First is to wait for deeper action, somewhere to 1.06, based on large butterfly shape. Second - use average position, with taking some part, say 30%, around 1.0650 K-support and take the rest around 1.06. This is more simple way to deal with. Both positions are based on butterfly, so invalidation point will be 1.0570.
 
Morning guys,

Just we've discussed yesterday bullish background and situation has changed drastically. News tell that this is because markets wait for hawkish Fed minutes. But this was widely expected since J. Powell statement in December. Hardly this is the reason. I suspect that first is - investors start forming new portfolios and sharp action could happen here and there in nearest 1-2 weeks. Second - political risks are involved, as gold is rising together with the USD. They can't choose US Senate Speaker for few times yesterday. Maybe some other reasons exist as well.

So, on the Dollar index we've got sharp rebound, and it would be better to not play against it by far:

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So, we do not consider long positions on EUR by far. Concerning short position, for the truth sake, setup is ready to use and stands in place. On 1H chart we have AB-CD upside bounce to 5/8 resistance, making Agreement resistance and "222" Sell pattern. Market is tricky now and volatile. But if you have no mental problems with this, you could consider this setup. Risk will be around 35-40 pips. If you're not sure and recent opposite strong swings is too much for you - then it would be better to wait for major data releases of this week and then make a decision. I still hope that we finally are getting start of monthly B&B trade, we'll see..

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Morning guys,

Market remains tricky but USD strength is becoming more evident, at least at current moment. Market makers are using the moment of coming to important data released and shake the boat. So, all currencies are choppy right now on intraday charts.

Daily EUR looks the same as DXY now. Trend is bearish here. As we've mentioned in video, at current moment other currencies, such as GBP, JPY also show signs of weakness:
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On 1H chart is our recent entry point - around Agreement resistance. 1H chart also has turned bearish. For the bulls - its nothing to do by far. Speaking about short entry, technical background is OK. But you should be ready for choppy action and data release. If it is suitable, then you could consider entry inside of this triangle. For this bearish background the invalidation point remains the same - above 1.0640 area. If market is bearish it should continue downside action.
IF you still are not sure concerning position taking, then it would be better to wait for data releases and make decision in the beginning of the next week.
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Morning guys,

So, ADP was relatively strong and our short entry setup with triangle has worked nice thankfully. Now all eyes on NFP... In recent few months correlation between NFP and ADP has dropped significantly and now good ADP absolutely doesn't mean good NFP. So, if you are holding shorts - think about result protection, and put stop at b/e at least.

Based on daily chart, nearest target is 1.0445. It makes Agreement with daily K-support area of 1.0430-1.0460 area. And if NFP will be strong indeed, it could be reached today.
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On 4H chart we have nothing special - EUR is breaking down the channel. But downside action is gradual, so it still could be just a pullback.
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Here is our triangle entry. Market has hit COP target. We see no good setups for the bulls. For the bears there are two ways of action. First is, not dealing with NFP, just wait for the pullback to 1.0580 K-resistance area, which probably happens only next week, or, if NFP will be poor. Second - try to use Stop sell entry order around 1.0505 lows. If NFP will be strong, market should keep going lower and you take position at the downside breakout. Actually these two ways are not mutually exclusives. The only problem with the latter way is extreme volatility before data release. Order could be triggered occasionally. That's why, think, decide what way is better for you personally.

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