USD is driving the show

Traders have pared some long USD exposure during European trade, predominantly against the EUR and AUD; however the risk of this happening was high as the elastic band had been pulled back way too far.

USD
Source: Bloomberg

The question is whether to re-apply shorts, and certainly in EUR/USD good selling has been seen at $1.0650. A poor US retail sales report has been behind the selling, but there is an increasing belief that next week the Federal Reserve could drop its ‘patient’ language, but offset this with a strong statement that the USD will play an increasing role in its monetary policy settings.

The USD is driving the show right now, and given how stretched the rally had become, any belief that the Fed will try and curb gains in the dollar has caused traders to pare back on some very tidy profits. Interestingly though, a simple pullback in the USD has set the equity bulls into action in multiple geographies. The S&P 500 is now testing the 38.2% retracement of the 3.9% decline seen through January to February at 2069 and an upside break here could suggest the market is ready to make a tilt at the all-time highs again. On the other hand there is strong uptrend support in play (currently at 2039) and a break below this trend could suggest a much deeper pullback is on the cards.

Watching price action in the S&P 500

In trading it can pay to let the market guide you into a position and that time could be now, so traders could look to buy a break of 2069 or sell a break of 2039. My bias is for an upside break.

In Asia, markets have generally been in bullish mood, with the Nikkei continuing to march higher, while Chinese equities are looking increasingly bullish. The ASX 200 is lower on the day, with banks giving back a portion of the gains seen yesterday. The idea that the [indices:AUASX 200 is seen by some as a quasi-hedge against the Fed lifting the funds rate seems to be true to a degree, although equity investors don’t think as short-term as FX traders; and one night’s short covering in the AUD hasn’t changed the investment landscape one bit.

The ASX 200 is shaping up for back-to-back weekly losses, but as I suggested yesterday if you feel the USD still has upside, then the ASX 200 will outperform.

Chinese equities turning bullish

The A50 cash index in China is looking very interesting indeed from a technical perspective and seems to be getting a boost from last night’s February lending data. Total social financing came in at RMB1.35 trillion and was nicely above expectations, while the M2 money supply at 12.2% was closer to the central bank’s target. The PBoC strengthened the RMB by 29 pips on the back of this today, which won’t surprise too many as we know authorities are keen to keep a stable currency to avoid capital outflows. Traders have also been talking about the absolute of China’s short-term foreign liabilities (which stand at around 9% of GDP), much of which is priced in USDs; weakening the RMB too greatly would cause real stress on the domestic corporates.  Of course the downside of not being able to weaken the currency too greatly is you effectively import other countries’ deflation, especially with EUR/CNY having fallen 11.5% this year.

Still for now these dynamics are second to the attraction of liquidity and central bank easing and the China A50 and CSI 300 cash look good for further gains.

The same is true in Japan, where the Nikkei has broken out with real venom and is eyeing the 19,500 level. It’s interesting as the JPY is actually finding better bids of late, but the price action in the equity market is outright bullish. The fact both the Nikkei and the TOPIX (the institutional preference as its market capitalisation weighted as opposed to price-weighted) are the best performing major markets is one thing, but the outperformance is seen in in USDs as well, which is something that is giving investors real encouragement. In Japan you have massive expansion of the balance sheet, huge portfolio adjustments by a number of massive pension funds (partly into domestic equities) and an economy that is seeing signs of improvement, including improved wage growth.

There are signs of divergence emerging in the oscillators, so this is worth watching to see if we witness a lower low in price, in turn opening up for a reversal in the trend. But for now it appears there is a wall of international funds making its way into Japan and it seems some of these funds remain unhedged.

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