Forex FOREX PRO WEEKLY, September 18 - 22, 2023

Sive Morten

Special Consultant to the FPA
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Fundamentals

This week we've got too many data, and probably it will be impossible to cover all of them in details here. Otherwise this read will be too long. So, I try to mention most important one, without details and concentrate on explanation of their effect on US and EU economies and EUR/USD rate. No doubts, inflation numbers have become a high spot of the whole week. With recent ECB signals on possible end of rate upside cycle, it puts the point in a question of USD domination. Investors now are turning attention on Fed meeting and start gambling on its next step. If just a week ago, there were no chances on rate hike in September - now, with new PPI and CPI numbers markets are not as sure as previously.

Market overview

The U.S. dollar was lower on Friday, after data showing a dip in consumer sentiment, but the greenback was still poised for a ninth straight week of gains, while the yen weakened to a 10-month low. The University of Michigan's preliminary reading of its Consumer Sentiment Index dropped to 67.7 this month from a final reading of 69.5 in August and below the forecast of 69.1 among economists polled by Reuters. However, consumers saw inflation lower on both a one-year and five-year basis.
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Earlier data from the Labor Department showed import prices increased 0.5% last month as fuel prices jumped, but underlying price pressures stayed subdued while a separate report from the New York Fed showed factory activity picked up in the state in September.

"None of the data currently points to a recession. Nevertheless, the fed futures still points to the end of next year, a lower rate," said Joseph Trevisani, senior analyst at FXStreet.com. If the credit markets are still convinced that when you increase rates as much as the Fed has, you eventually get a recession ... where do people go? They go to the dollar."

The Federal Reserve will hold a policy meeting next week on Sept. 19-20 and the central bank is largely viewed as keeping interest rates unchanged, with a 97% expectation for no action, according to CME's FedWatch Tool. After edging higher earlier in the week, expectations for a 25 basis-point hike at the November meeting have declined to 30.6% from 43.6% a week ago, with a small chance of a cut being priced in as early as January.

European Central Bank's (ECB) policy announcement, in which the central bank raised rates to a record-high 4% but signaled it was likely done with hikes. However, ECB policymakers pushed back on the idea the central bank was done with rate hikes, saying rates will be kept high for an extended period and could even be raised again if needed. The euro was on track for a ninth straight weekly fall against the dollar. It seems that markets do not believe too much to this verbal intervention.

“The ECB has just given dollar bulls another reason to start selling the euro,” Nomura Holdings Inc. responded. “We expect short positions in the euro to gain momentum, not only against the dollar, but also against other currencies.”

The European Central Bank cut its growth projections for the next two years while lifting some of its inflation forecasts, raising the spectre of stagflation, a period when the economy suffers a double whammy of no growth and high inflation. The GDP new growth vs revised in 2023-2025 is 0.7% (0.9%) 1.0% (1.5%) 1.5% (1.6%), while inflation is 5.6% (5.4%) 3.2% (3.0%) 2.1% (2.2%).

"The consensus is that this was a dovish hike, the last one and it's clear skies from here," said Charles Diebel, head of fixed income strategy at Mediolanum Asset Management.

The decision had been on a knife edge as policymakers and investors had to balance still-sticky inflation with a deteriorating euro area economic activity. Inflation concerns ultimately won out at the ECB, but for traders, growth seems the bigger concern as they stood firm with their bets on rate cuts next year, expecting a first 25 bps cut by June.

August was the month Europe's consumers finally caved. The services sector fell into contraction for the first time this year, compared with 13 straight months of shrinking activity for manufacturing. Activity across the broader economy has withered and economists believe a euro zone recession is rapidly becoming inevitable, particularly given deteriorating business activity.

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As a bottom line -
"Based on its current assessment, the Governing Council considers that the key ECB interest rates have reached levels that, maintained for a sufficiently long duration, will make a substantial contribution to the timely return of inflation to the target," the ECB said.

At the same time, a majority of Fed policymakers will probably still pencil in a year-end policy rate of 5.6% - one quarter point above where it is now. SGH Macro Advisors' Tim Duy is among the minority of economists who believe economic circumstances will in the end force the Fed to raise rates again later this year, even if some Fed policymakers themselves see that forecast more as "cheap insurance" than a likely outcome.

Duy also expects policymakers to signal rates will stay higher for longer, penciling in just two rate cuts next year compared with the four anticipated in the Fed's June summary of economic projections. Many other economists also expect Fed policymakers to signal fewer rate cuts next year. Financial markets are currently pricing for rates to fall to 4.4% by the end of 2024 and 3.8% by the end of 2025.

Cleveland Fed President Loretta Mester told Reuters she wants to set policy so the Fed's 2% inflation goal is reached by the end of 2025. For her part, that may mean a delay to any rate cuts. Treasury yields rose ahead of the Federal Reserve policy meeting next week, with two-year yields edging above the 5% threshold amid worries that restrictive interest rates will be in place for longer than expected.

And, guys, take a look at recent 10-year bonds Auction results - investors demand solid premium, compares to previous months - almost 0.3% (4.28% vs 3.99%). What rate cut might be on a horizon? US 10- year real rate stands at top near 2%. We suspect that market at the eve of the "big despear", when cruel reality comes. Inflation will raise more in next two months. So, it might be the pause in September but we expect that rate could raised in November and even December.
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Hedge funds and speculators are still heavily long the euro, rate differentials will move against it - especially in relation to the yen and dollar - and the euro zone's comparative economic outlook is bleak, especially versus the U.S. Against that backdrop, could the euro soon be gunning for parity with the dollar? It's 6% away, a notable but not an insurmountable distance to cover.

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"A shift lower in EUR rate expectations from here, alongside the potential for U.S. rate cuts to be priced out of the market, makes downside potential for EUR-USD most compelling," HSBC currency analysts wrote on Thursday after the ECB rate hike. They see the euro weakening to $1.02 by the middle of next year.

From a market positioning standpoint, the scope for more euro downside is compelling too. The latest Commodity Futures Trading Commission data shows that funds have reduced their net long euro position to a seven-month low of 136,000 contracts, but that is still a substantial $18 billion bet that the euro will appreciate. It is large by historical standards, and given the euro's dwindling rate appeal relative to its peers, it is likely to be cut further in the coming weeks.

The euro could fall more against the yen than the dollar, although the U.S.-euro zone divergence will get more attention. The economic signals from either side of the Atlantic on Thursday were telling - U.S. retail sales smashed expectations and producer price inflation was higher than forecast, while the ECB cut its growth outlook to 0.7% this year and 1.0% next. No one knows what the future holds - least of all economists - but while the U.S. economy is flirting with a possible soft landing, the euro zone is flirting with a possible recession.

The divergence seems pretty well entrenched. Citi's U.S. economic surprises index has been positive since May and the euro zone index has been in negative territory since May. Indeed, excluding the pandemic distortions of early 2020, the euro zone surprises index lows from July were on a par with levels last seen in the depths of the Great Financial Crisis.

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How much of that is already in the euro's exchange rate remains to be seen, but there is nothing obvious to suggest the dollar's rate and yield advantage will shrink any time soon. Euro zone interest rate traders reckon the ECB is done raising rates, and are now betting on around 70 bps of rate cuts next year. U.S. rates traders are still on the fence over another rate hike this year, and have gradually been scaling back 2024 rate cut bets recently.

"Today's ECB policy update and stronger U.S. data for Q3 is further encouraging those expectations placing downward pressure on EUR/USD," MUFG's Lee Hardman wrote on Thursday.

What recent US data tells us

So, the raising of the US inflation is, no doubts, the major news. CPI shows 14-months peak. It seems that J. Powell nervousness is not in vain. PPI is also at 14-months , peak, while Finished goods PPI is at +2.1% per months. It was higher only just once, in 2022 - the peak in 49 years. Finally PPI for the entire list of industrial goods — -4.4%. Yes, this is deflation, but much less than in July and even more so in June (there was -9.5%). The fact that deflation continues suggests that there is no growth in industry, and the general decline in the economy continues (and indirect data confirm this). Thus, the price increase is not related to the incipient growth and is of a different nature. Here are pictures and few additional ones that we need in below:

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An industrial collapse has fully formed in the European Union. Accordingly, the index of economic sentiment in the eurozone (ZEW survey) has been in the red for 5 months in a row.

What are the possible options? There are two of them. The first is the growth of costs, that is, there is not monetary inflation, but inflation of expenses. The second option is an increase in import prices, which allows purchasing managers to raise domestic prices. This needs to be dealt with, but in any case, it does not affect the overall picture in the US economy, rather, it worsens the situation from the point of view of the Fed's logic.

Apparently, it will not be possible to find an unambiguous reason for the increase in costs in the US economy. This is, in general, a normal situation in a structural crisis, when a decrease in demand and simplification of the structure of the economy (and the second automatically follows from the first) begin to increase all sorts of costs. And this process will continue all the time that the structural crisis continues. Indirect indicators clearly show a change in the structure of the economy. Of course, they don't say anything about how it changes, but, for example, the Fed interest payments on reverse banking Repo agreements in the table above.

Losses have just reached $100 billion, or $758 million a day. Before all these crazy games with interest and money pumping began, the Fed sent its profits to the US Treasury every year. But now the Fed has huge paper losses on its bond portfolio and huge daily losses on the money it has to pay to commercial banks to keep the system from collapsing.

Another picture, the interest rate margin in banking sector. It is dropping. As can be seen above, the weighted average loan rates increased faster than deposit rates, which led to a significant increase in banks' interest margin from 4-4.2%, which was observed before the tightening cycle of the Fed policy, to 4.7-4.8% by mid-2023 (the maximum margin since Q3 2012). But this is a temporary effect. Now with massive deposits run and active tightening Fed policy, the fight among banks for deposit base is accelerating.

The weighted average rates on the deposit base will continue to grow actively at a rate of 0.35-0.4 percentage points per quarter, i.e. they may grow to 2.5% in Q4 2023. Loan rates, on the contrary, slow down due to a decrease in demand for loans, which exacerbates the competition of banks for borrowers, so the net margin of banks will begin to decline rapidly from Q3 2023.

At the same time, the acceleration of loan delinquencies will begin (that we already see), as a natural reaction of the system to the extreme cost of borrowing, which will lead to the accumulation of credit write-off costs. This is, in fact, a description of one of the mechanisms for increasing costs for the real sector of the economy.

In general, all profit in banking sector reported is a myth. SVB also had sweet statement and everybody knows how it has finished. For every one dollar of credit written off, an average of 4 dollars of reserves are created for credit losses in severe crises. Now banks have formed reserves for credit losses of 1.72% of the loan portfolio. This allows them to deduct an average of about $1.7 for every dollar of write-offs, however, in a crisis it is necessary to have at least 2.5% of the loan portfolio covered (in the 2008 crisis it was 3.6%).

The current volume of loans is almost $12 trillion, if write-offs reach 0.4–0.5% for the quarter - this is about $55 billion, which will require at least $150 billion to create reserves - this is higher than the current ones, which is 7 times (!!!) and almost comparable to net interest income ($174 billion).

Resolving of the job market riddle


First is, take a look at these charts:
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And weekly hours:
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We see that since the Fed began raising interest rates, the labor market has gradually softened. Specifically, employment growth is slowing, there are fewer job openings, shorter workweeks, lower layoff rates, and lower wage growth among those changing jobs, see charts below. Given that the Fed will keep interest rates this high for another nine months, it's unlikely that the lines on these charts will suddenly start moving sideways.

The likely scenario is that the trends in these charts will continue. In short, economic data is getting weaker as Fed rate hikes hit consumers and businesses harder and harder. But here is very unique situation when the number of jobs increases as working hours decrease. How it could be? It should be the opposite. If my workers already work hard and full capacity, I hire more, but I do not keep big staff and let them to work just partially. This is nonsense. And how it could possible that with overall collapse on real estate market and degradation of manufacturing, the number of payrolls are raising.

The answer is in Hollywood movies. Have you watched "The Big Short" or "Wall Str: Money never sleeps". The bottom line is - all so called "speculators" have to find the simple job. This is what we see now. Those who actively made speculations with real estate market or on any other market in period of "zero rates" now has lost the earning. Real Estate market collapse and stagnating, because it makes no sense to Sell the house that you've bought with near zero mortgage rate and buy new one with the rate around 8%. All these people has lost their earnings and... have to find the job.

In fact, it relates to common people as well, who was buying house at primary market, paying low mortgages while house was under construction and then selling it on secondary one at higher price. So, the current employment growth is to some extent related to this. Low unemployment is not a consequence of a healthy economy, but a consequence of a decrease in household incomes and the high cost of credit, because demand can be supported not only by growing incomes, but also by lending. This explains phenomenon why employment is raising on background of decreasing of weekly hours. As you understand, this is temporal process and soon unemployment will accelerate.

Conclusion:

Today we have discussed recent bulk of data, what does it mean and also have shown you some specific and interesting moments in job market and other sectors. Tomorrow in gold report we will closely take a look at the US interest rates and big problems that are evident already. But, still our task is not just analyzing the economy but make a conclusion on specific currencies and EUR in particular.

As you could see from the recent ECB report - we correctly have suggested last week that ECB will get the last chance to change the rate, and they have used it. Next time, EU economy data will become worse and we closely will be looking for coming PMIs. Sharp raising of Germany 10 year yield is not the result of ECB policy but reflects the decreasing of credit quality. In the US we see the same - just take a look at Auction results that we've mentioned and budget structure. But, still with all coming disaster in the US, EU and the US economy conditions are incomparable. EU is loosing heavy industry, it is migrating to the US, other countries where it could get access to relatively cheap energy. It already impacts consumers ability to spend. This process continues. Based on recent CFTC data shown above, investors are not totally possessed for downside trend on EUR/USD, which means that statistics and the Fed activity could trigger miserable plunge.

We think that this process will be exacerbated by the Fed and its new rate hikes because market absolutely doesn't ready for that and it will become absolute surprise, as soon as we will get inflation data in October and November. Both these factors and recent revision of forecasts by big banks show that our long-term view seems correct. Now market considers 1.02 level but our technical view suggests 0.9 area that we keep since last year, despite that the road to the target is winding.
 
Technicals
Monthly

Despite some volatility last week, monthly chart shows no surprises and price gradually tending to our next 1.06 support area. Here we do not have any additional comments by far.

Tactically, 1.0570-1.060 level is of our particular interest by few reasons.

Thus, on monthly chart it is interesting because of YPP, and downside breakout will mean that long-term sentiment has changed into bearish. Second, 1.0480 - 1.05 is yearly low. As you understand downside breakout will have far-going consequences and mostly in sentiment terms.

Finally, although fundamental background doesn't suggest this, but this is an area where potentially bullish grabber might be formed - or not formed and trend will turn bearish. All these things should happen in nearest 1-2 months...

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Weekly

There are no big changes on weekly chart either. Formally, the divergence has been completed, as price has challenged recent lows for 4 pips. Market is entering turbulence zone of wide K-area 1.0430-1.06. So, we should be ready for higher volatility and possible unexpected pullbacks on intraday charts, because when price stands inside of weekly K-area, the behavior of counterparties is becoming less predictable. Just watch for the patterns.

Second is, existence of K area could become a reason of appearing nice bullish short-term setups on daily and lower time frames, and EUR starts showing the reaction on K-area touch:

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Daily

Context remains bearish here. It seems that our Friday bounce has happened. Market is not at oversold, we do not have any Fib support levels - weekly one stands only around 1.0611. Price stands near the lows after solid drop, without any attempt to show higher pullback. All these moments tell that daily bearish context is valid:
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Intraday

Here is no destruction of the bearish background: 3/8 butterfly bounce that we've discussed has happened. Slightly higher we have K-resistance and possible bearish grabber. Overall price action stands tight, in a shape of bearish flag pattern.

As it was before - from the bearish point of view we do not want to see EUR jumps back above the K-area, the trend line and into daily flag pattern. It means that 1.0730-1.0745 is a vital area for short-term bearish setup. At the same time, downside target is also relatively close - 1.0611 is weekly Fib level, 1.0570 is a daily oversold. Thus - somewhere around 1.06.
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On 1H chart our triangle has been broken down, market has made upside AB-CD pullback, as reaction on butterfly downside target and secondary downside AB=CD target on daily chart. Now everything seems good as we have "222" Sell and price action that we already discussed last week on gold market - take a look that market is erasing of recent upside acceleration, that suggests sharp change in sentiment.

Still, if you plan to go short - keep an eye on 1.0650 support, potential grabber and 1.0645 lows. To confirm bearish action, EUR has to erase all of them and keep dropping.
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Morning everybody,

Market is relatively quiet as always before the Fed meeting. On daily chart we have nothing to comment. But on lower time frames it is very tricky situation. Based on EUR performance, it seems that market is preparing for dovish Fed. But if you take a look at 10-year US bonds - they are not. Yield is not dropping.

Another thing, that is in my mind - Fed could try to act in advance. October is a pause time, and no meeting, but right in Sep and October we get new CPI that absorb all this madness on fuel markets. It makes me thing, that it is not the fact yet that Fed will keep rate flat. So, for some case - be prepared for doom and gloom.

On 4H chart we keep watching for our vital bearish area - 1.0720-1.0740, that includes K-area and trend line resistance. To keep short-term bearish context valid, EUR has to stay below this area. Upside breakout, immediately leads to appearing of reverse H&S, and higher upside action:
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On 1H chart EUR has not formed bearish setup that we've discussed in weekend and turned up immediately after open. For now I do not see many things to do. Only scalp traders could try to take long position with target somewhere around 1.0710-1.0720. We intend to monitor market performance around vital area. If miracle will happen and Fed will raise the rate again - it might be the bet of the week. Besides, since this is a "culmination" bearish point, we do not need to hide stops too far, it might be placed right above the trend line. This is getting a little dark....
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Morning guys,

So, the level of uncertainty today is rather high. Maybe Fed will not change the rate (but we still keep small chances that this could happen), but they definitely will change the rhetoric because of too fast fuel prices rally. That's why whatever position we take today - it anyway will be the bet on Fed result.

On daily chart we see nothing by far. Context remains bearish:
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On 4H chart 1.0720 is touched and if you've taken short position - you could move stop to breakeven and see what will happen. Here overall idea is the same - 1.0730-1.0740 is a vital bearish area, market has to stay below, otherwise context will be broken and higher upward action is possible:
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On 1H chart - you have to choose your own poison. Market is forming H&S. If you believe in more hawkish statement or even rate hike - think about short entry with stops above the head. No? Do you think that Fed will keep dovish tone and the rate? Watch for H&S failure and market action to 1.0710. You target is XOP around 1.0745. If you conservative enough - do nothing, just wait when Fed will be released....
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That's all guys, technicals now are taking the backseat. Your position depends only on your view on Fed results. BTW, yields also send tricky signals, 10 year hits the top from 2007 and doesn't drop. Something is going to happen...
 
Morning guys,

So, as you could see - the trading of Fed release was a bit challenge yesterday. Long trade has not reached predefined XOP as J. Powell has started speech a bit earlier ;) (could he wait just 20 min more... LOL). Bearish setup works perfect but reversal was so fast that hardly it was a chance to catch the entry moment.

Anyway, Fed statement was not as dovish, despite they were not brave enough to change the rate in September. Anyway... now EUR keeps bearish context but it stands too close to weekly K-area, starting from 1.0610:
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Thus, theoretically we could try to take another short position, but have to control what is going on intraday charts. On 4H chart - everything was perfect, market was not able to return back in flag consolidation and remains under K-resistance:
eur_4h_21_09_23.png


Now, just to not take too much risk, we could consider B&B "Sell" on 1H chart. Supposedly around 1.0665-1.0675 at former neckline of failed H&S pattern, it is possible to consider short entry. If we get DRPO "Buy" instead, well, in this case pullback might be higher and it is more complicated scenario as DRPO is not a continuation pattern.
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Morning everybody,

So, B&B yesterday has worked excellent, but now EUR is coming to an area of "tricky performance". Because 1.0611 is a first level of a bit weekly K-support area. It means that despite bearish context and strong fundamentals, downside action could be hard and volatility will increase. If you trade on daily+ time frame - this is obviously not an area where you need to sell.

Even right now, take a look - we've got minor grabber, EUR challenges twice this level already. Despite that other markets shows outstanding collapse on a background of dollar demand:
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On 4H chart market was held 1.0740 resistance well, and take a look it has dropped to the next downside consolidation area. Multiple divergences are starting to form. Grabber that you could see - is already done. Once again - this was just minor W&R, no downside breakout
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On 1H chart our B&B has done well, later we even have got "222" Sell. And now we have not too many options. Mostly only scalp traders could trade. Because for short position is not a good point - we're at weekly K-support. For long position - is not yet a good point, because we do not have any bullish context and patterns.

Thus, the only thing that currently could be done here is a scalp selling of the rallies and close near the current bottom of 1.06. For trading process you will have to drop time frame to 15-min probably. But general logic is as follows. Market should stay in current consolidation under 1.0680. If pullback happens - watch for Fib resistance levels, patterns etc., that we usually do, and sell rallies with out point around 1.06 lows. For now, first level on the way is 1.0661 or you could use tighter ones, just of the recent drop.
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That's unfortunately all that could be done here. This is always happens when technicals and fundamentals are clash foreheads around strong levels.
 
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