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Technical analysis: a positive bias to risky assets

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Like many who assess the event risks in the coming week to understand the potential distribution of outcomes, we also consider the platform that has been set, and how traders could act into the new week.

As is so often the way in recent times, with such lively news flow and so many conflicting cross-currents, once again it’s a case of ‘where do I even start?’

One place I can start is how traders feel about a slower pace of Fed tightening. While options expiry may have played a hand in the upbeat/positive flow on Friday, the WSJ’s Nick Timiraos article has now been well-dissected by traders. It certainly puts a big emphasis on the importance of the 2 Nov FOMC meeting, where the Fed should signal a slower pace of hikes in the meetings ahead. A factor that was already priced in to the markets, but some feel this signal was an uber-soft ‘pivot’.

While we are certainly getting ever closer to a pause in the hiking cycle, the other big elephant in the room is Fed Quantative Tightening and for those modelling where the USD, Nasdaq and S&P500 are headed, the Fed reducing the balance sheet by $95b p/m is still an important input. Until Fed buybacks are rolled out, reduced liquidity should limit the S&P500 upside at the 200-day MA at 4134.

Comments from San Francisco Fed president Mary Daly had the market feeling confident that a Fed terminal rate above 5% is the likely ceiling on rates pricing. The combination of the WSJ/Daly news hitting the market saw pricing for the March FOMC meeting fall 13bp, in turn causing a huge curve steepening. US 5yr real rates fell a massive 28bp to 1.57% and eye a test of the bottom of the range at 1.50%. This was good for a 130-handle rally in the S&P500, a 2% reversal lower in the DXY and a 3% reversal higher in AUDUSD and $38 in XAUUSD.

A positive bias to risky assets

It feels like there could be more positive flow in the tank, so the early view is the S&P500 tests the 5 Oct swing high of 3807, where a break could see 3895, possibly even 3915, come into play. With 47% of the S&P500 market cap reporting this week, corporate outlooks collide with evolving macro. Names like Apple, Microsoft, Amazon, and Meta hit us with numbers.

The form guide says they’ll likely beat expectations for the reporting quarter, but the question is whether they’ll offer enough visibility in the outlooks for analysts to alter their 2023 earnings assumptions. With consensus 2023 EPS at $240, most feel this will be taken closer to $220 over time, but whether we get the downgrades in these numbers or in Q4 earnings is unlikely. In theory, moves in US rates should remain the dominant driver of equity returns.

If equities do push higher, the AUDUSD has scope for 0.6500, although Aussie Q3 CPI (Wednesday) will influence that call. With 29bp of hikes priced for the 1 November, at the Reserve Bank of Australia meeting, we’d need to see something significantly above the consensus of 7% headline / 5.5% trimmed mean, for the market to anticipate a 50bp. The AUD is more likely to focus on the AUD terminal rate pricing, which sits above 4%.

A lively week for the EUR

The need to hold USDs to hedge equity drawdown risk is reduced on a further equity rally and the USD index could push to 110, although EURUSD rallies may well be capped into 0.9950 and the bear channel highs.

The ECB meeting should see the central bank hike by 75bp and again the market is trying to understand how high the ECB could take the deposit rate in 2023. The market prices a terminal deposit rate of 3%, which means they take rates around 100bp above the perceived 2% neutral rate. There will be focus on the outlook for Quantative Tightening, although if we get any colour on balance sheet reduction it will be very loose. Keep an eye on the Italian 10yr Governement Bond and German 10yr bund spread. If this spread increases then EURUSD should fall and vice versa.

One can also add the Bank of Japan’s actions to intervene causing USDJPY to trade 151.61 to 146.22. While our client skew was long JPY on Friday as a mean reversion play, there would have been some pain in that move felt in the broader market, with so many leveraged funds short JPY for carry and rate differential trades.

The Bank of Japan meeting in focus

The BoJ has been drawing down their US Treasury holdings, which partly explains the rise in US bond yields, at $20b a clip, FX intervention is not a cheap exercise to move one’s currency ¥5. However, with the market feeling more confident of nearing a ceiling in Fed terminal rates pricing and US real rates rolling over, this is the time the Bank of Japan/Ministry of Finance could act as momentum traders and come out again on Monday and intervene. That would truly scare off those core short JPY traders. Pepperstone clients agree, with 66% of open positions in USDJPY still held short.

The BoJ meeting on Friday will be worth putting on the radar. While the bank should lift their inflation forecasts for 2022 and 2023, it seems highly unlikely we see changes to the policy settings. Clearly, the market does not see the current framework as sustainable and every day last week the BoJ had to step in with special bond buying operations to keep the 10yr govt bond at 25bp. Japan’s 10yr swaps trade at 65.5bp, and this tells a fitting picture.

Perhaps most ironic is that the Japanese government will likely roll out a sizeable fiscal stimulus later this week, with some of this working to help households offset higher prices. With the BoJ perennially the most dovish central bank in G10 FX, there is a clear feedback loop here. Do also consider we get Tokyo CPI 2 hours or so before the BoJ and the market expects this to rise from 2.8% to 3.3%.

Who will lead the Tory Party?

We watch the GBP closely given the Tory leadership race. I wrote about the timetable here, and why the real moves in GBP come on the perception of how next Monday’s fiscal statement is handed down. The situation is fluid and at this point, A Sunak victory is the market-friendly outcome and is good for a short-lived GBP relief rally, and potentially takes market pricing of the 3 November Bank of England meeting closer to 75bp. Speeches from BoE members Catherine Mann, Ramsden and Huw Pill and Sam Woods could influence that pricing.

China’s political influence

USDCNH could influence the broad US pairs, but there will be a focus on China equity markets, The weekend visuals of former President Hu being escorted out of the closing ceremony have been widely discussed. Whether it moves markets is another thing. A weaker USD would be welcomed though, so watch the moves early in the week, where our opening calls look constructive at this stage.

Key event risks traders need to navigate in the week ahead:

  • A huge week of US corporate earnings – we see 47% of S&P500 market cap reporting including Apple, Microsoft, Amazon, and Google among others
  • The Tory Leadership battle – the bulk of recent betting capital is for a Sunak win
  • ECB meeting (Thursday) – a 75bp hike is fully expected. With Eurozone manufacturing, German IFO, and CPI it could be a lively week for the EUR/Dax40
  • Aussie Q3 CPI (Wednesday) – the consensus estimate is for headline CPI to push to 7% (from 6.1%). This could be influential on 1 November Reserve Bank of Australia pricing which expects a 25bp hike
  • Bank of Canada meeting (Thursday) – watch CAD exposures as the market prices 66bp of hikes. It could go either way; 50bp or 75bp?
  • Bank of Japan meeting (Friday) – no policy changes expected but the market continues to test the BoJ’s resolve and expects a policy change in 2023
  • US consumer confidence (Wednesday) – the market expects this to fall to 105.3 (from 108)
  • US employment cost index / ECI (Friday) – the Fed look at this data closely, so the market will too. The consensus is for 1.2%, in line with the 1.3% pace seen in Q2.

This article is brought to you in association with Pepperstone. All opinions expressed in this article are from the author and do not necessarily represent the opinions of The Armchair Trader.

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This article does not constitute investment advice. Make sure you do your own research or consult a professional advisor.

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