EUR/USD close to over sold territory, fundamentals favour fading rallies

It’s been almost six months since I’ve posted anything on this site. After many, many years trading, brokering and analyzing capital markets I needed a sabbatical to clear my mind in order to be able to take a look at markets through fresh eyes. During that time I took time off to visit Europe on two occasions and spent about a month traveling around, eyes and ears open to see if I could glean some insight into what is driving the local economies and how the citizens of those countries feel about life in general. It was an interesting exercise and I’ll explore some of those themes in my “Trip Notes” section.

TECHNICALS

At time of our original analysis (September 16th) EUR/USD closed at 1.1028, off 1.9% since April 5th. In historical context for that period, it was pretty tame (the third least volatile period since the inception of the Euro) and less than half the average 5.1% fluctuation for that period .

Reviewing the 20 summers since the Euro was launched it’s surprising that 9 out of 20 saw EUR/USD decline, surprising because tourist inflows have always bolstered the current accounts of legacy currency countries, particularly Italy, Spain and Greece. During our European sojourn it was patently obvious that tourism continues to be the mainstay of the Southern European economies.

The average of EUR/USD declines during the periods under review were 6.7% and the rallies 5.4%. Adjusted for outliers (highest and lowest) those fluctuations average 6.0% and 5.1% respectively. The 2019 spring/summer decline (referring to our selected dates – April 5 / September 16) of 1.9% was the smallest of any decline since the Euro was launched. The 1.1403/1.0926 Hi/Lo was a mere 4.4% fluctuation and reflects the generally subdued mood in major FX pairs during the summer of 2019. It should be noted however that the September low was the lowest EUR/USD has registered since May 2017, which hints at further downside probes.

Our fair value Bollinger Band / moving average model that monitors 15 components from the 24-Hr M/A to the 200 DMA updated yesterday, reveals EUR/USD is just 0.6% above the -2.5% blended model Bollinger Band midpoint. This is due to the longer term valuations being stretched. The upper band of the blended oversold model is located at 1.0971 and the lower band 1.0896,

The intermediate components would allow EUR/USD to dip to 1.0889 and the medium term components 1.0856. The lowest -3.0 Bollinger Band reading we use resides at 1.0828 (75-DMA).

The implication from all this is that EUR/USD at 1.0998 is about 1.6% above it’s lowest attainable level and starts becoming oversold as high as 1.0978, which is why it has struggled around to break significantly below 1.1000. 1.0860-1.0945 registers heavily oversold for various averages between the 24-HMA and the 200-DMA, consequently algos that incorporate similar types of value indicators will be reducing short positions as they near those parameters.

At time of writing (September 16th) EUR/USD closed at 1.1028, off about 1.9% since I last reviewed the markets (April 5th). In historical context for that period, it was pretty tame (the third least volatile period since the inception of the Euro) and registered less than half the average fluctuation over that period (5.1%).

Reviewing the 20 summers since the Euro was launched it’s surprising that 9 out of 20 saw EUR/USD decline, surprising because tourist inflows have always bolstered the current accounts of legacy currency countries, particularly Italy, Spain and Greece. During our European sojourn it was patently obvious that tourism continues to be the mainstay of the Southern European economies.

The average of EUR/USD declines during the periods under review were 6.7% and the rallies 5.4%. Adjusted for outliers (highest and lowest) those fluctuations average 6.0% and 5.1% respectively. The 2019 spring/summer decline (referring to our selected sates – April 5 / September 16) of 1.9% was the smallest decline of any decline since the Euro was launched. The 1.1403/1.0926 Hi/Lo was a mere 4.4% fluctuation and reflects the generally subdued mood in major FX pairs. It should be noted however that the September low is the lowest EUR/USD has registered since May 2017, which hints at further downside probes.

Our fair value Bollinger Band / moving average model that monitors 15 components from the 24-Hr M/A to the 200 DMA reveals EUR/USD is closer to it’s midpoint oversold area than either the normal or overbought indicators. EUR/USD is just 0.6% above the -2.5% blended model Bollinger Band midpoint. This is due to the longer term valuations being stretched. The upper band of the blended oversold model is located at 1.0971 and the lower band 1.0896,

The intermediate components would allow EUR/USD to dip to 1.0889 and the medium term components 1.0856. The lowest -3.0 Bollinger Band reading we use resides at 1.0828 (75-DMA) and whilst there may be a slightly lower level between the 55-DMA -3.0 Bollinger Band reading and the 75-DMA reading it would not be significantly lower.

The implication from all this is that EUR/USD at 1.0998 is about 1.6% above it’s lowest attainable level and starts becoming oversold as high as 1.0978, which is why it’s struggling around 1.1000 today. 1.0860-1.0945 registers heavily oversold for various averages between the 24-HMA and the 200-DMA, consequently algos that incorporate similar types of value indicators will be reducing risk as they near those parameters.

Short term M/As will be the first to get stretched, 1.0845 represents a -4.1% Bollinger band reading and whilst attainable (we pressed -4.5 on Sep 18 at 1.1013) would likely be short-lived and prompt profit-taking. The recent high was 1.1073 on Sep 19, so if we press as low as 1.0845 look to scale out of shorts and reload higher up.

The beautiful feature of Bollinger Bands is they expand and contract with volatility, so as of today a -4.5 reading on the 24-HMA would be 1.0873. This feature helps you avoid scaling out too early from positions or, more importantly, entering a counter-trend trade too early if you’re a value seeker looking to catch the proverbial falling knife.

The beautiful feature of Bollinger Bands is they expand and contract with volatility, so as of today a -4.5 reading on the 24-HMA would be 1.0873. This feature helps you avoid scaling out too early from positions or, more importantly, entering a counter-trend trade too early if you’re a value seeker looking to catch the proverbial falling knife.

The recommended setting for Bollinger Bands is -2.0 BUT through trial and and with different instruments we’ve found it better to experiment with that. Over time I’ve found the 24-HMA setting should be higher, +/- 2.5 for overbought/ oversold and +/- 3.5 for overbought/ oversold however once you get out to 72-hrs it;s better to revert to +/- 2.0 and 3.0. For convenience sake you can look at the mid , 3.0 for short term and 2.5 for longer term BUT when markets are less volatile or the trends are muted you can miss trades by having your markers too high or low.

As an example, when we hit the 1.0926 low the 24-HMA Bollinger Band reading was just -2.2 which is why you have to also monitor the longer term readings. When we hit that low the 200-HMA Bollinger Band was at -2.6 and had broken through the -3.0 level about a day earlier – a warning signal that we were approaching heavily oversold levels. The 21-DMA Bollinger Band registered -2.6 at the 1.0926 low and as the bands contracted, registered a -2.9 reading 7 days later at 1.09265, which formed a double bottom, a second bite at the cherry and a clear warning a bounce was coming.

The beautiful feature of Bollinger Bands is they expand and contract with volatility, so as of today a -4.5 reading on the 24-HMA would be 1.0873. This feature helps you avoid scaling out too early from positions or, more importantly, entering a counter-trend trade too early if you’re a value seeker looking to catch the proverbial falling knife.

The recommended setting for Bollinger Bands is -2.0 BUT through trial and error and with different instruments we’ve found it better to experiment with that. Over time I’ve found the 24-HMA setting should be higher, +/- 2.5 for overbought/ oversold and +/- 3.5 for overbought/ oversold however once you get out to 72-hrs it;s better to revert to +/- 2.0 and 3.0. For convenience sake you can look at the mid points, 3.0 for short term and 2.5 for longer term BUT when markets are less volatile or the trends are muted you can miss trades by having your markers too high or low.

As an example, when we hit the 1.0926 low the 24-HMA Bollinger Band reading was just -2.2 which is why you have to monitor what the longer term readings are also. when we hit that low the 200-HMA Bollinger Band was at -2.6 and had broken through the -3.0 level about a day earlier – a warning signal that we were approaching heavily oversold levels. The 21-DMA Bollinger Band registered -2.6 at the 1.0926 low and as the bands contracted, registered a -2.9 reading 7 days later at 1.09265, which formed a double bottom, a second bite at the cherry and a clear warning a bounce was coming.

EUR/USD chart showing Bollinger Band deviation at the same price level with band width contracting

Evidence that the EUR/USD market is in a state of flux can also be found on mixed candlestick formations over the past 3 weeks, a bullish firefly, followed by a bearish gravestone doji, a bullish engulfing candle, followed by a bearish hammer. Every one of those signals if followed would have netted a decent profit if acted upon and since then we’ve experienced sideways action with a negative bias.

Conflicting candlestick formations

Technically, our moving average/ Bollinger Band model once more shifted maximum short which is its maximum short and is at its most vulnerable. Remember, oversold valuations start registering from 1.0978 to 1.0942 for the ultra short term M/As out to the medium term M/As, so trailing stops and oversold targets are probably the way to go.

FUNDAMENTALS

This section we compiled Friday after stocks flirted with the year’s highs, the Dow closed down 0.59%, the S&P closed down 0.49% and the Nasdaq 0.8% on triple-witching day. The Fed announced it will maintain its daily repo operations until October 10th, easing recent quarter end USD funding concerns but Fed Chair Powell’s post- FOMC comments still hang in the air, the Fed’s easing stance can no longer be taken for granted.

FUNDAMENTALS

This section we compiled Friday after stocks flirted with the year’s highs, the Dow closed down 0.59%, the S&P closed down 0.49% and the Nasdaq 0.8% on triple-witching day. The Fed announced it will maintain its daily repo operations until October 10th, easing recent quarter end USD funding concerns but Fed Chair Powell’s post- FOMC comments still hang in the air, the Fed’s easing stance can no longer be taken for granted.

The shortage of reserves in the US banking system will hang over the market throughout Q4 into the New Year and will make overseas participants in US money markets wary of their balance sheet status. That should buoy short term US interest rates and underpin the US dollar, however looking at the DXY and the April 5 and September 16 2019 dates we reviewed in the Technicals part of this paper the DXY has only advanced 1.3%, which tells us that Euro weakness has also contributed to the single currency’s decline.

Despite the Fed clipping 0.25% off the Fed Funds target rate to this week (now 1.75-2.0%) vs the ECB moving rates 0.1% more negative (to -0.5%) EUR/USD has remained under pressure which seems more related to Fed Chair Powell’s enigmatic remarks as well as the obvious dichotomy between different camps on the FOMC.

Whilst most pundits expect the ECB to maintain rates at current levels for the next 12 months, Fed watchers are also split, whilst markets are still pricing in a roughly 45% chance of an October rate cut, it seems unlikely given the internal schism apparent after Wednesday’s press conference. The meeting’s minutes will be strongly scrutinized for more clues in 3 weeks time which should tell us how data dependent Fed policy is. Most market participants concur that the biggest risk on the horizon is that US economic data picks up and derails further interest rate cuts.

There’s widespread talk of a recession in Germany which was reflected in the last Ifo index on August 26 that was dismal. A recent Economist Magazine report attributed the economic slump to the export sector, primarily car exports that have slumped due to poor demand in China and the UK. Car production is off 17% this year according to the Economist which also notes a drop in demand for Germany’s predominantly diesel fueled motor vehicles.

The bigger issue with Germany is its massive current account surplus, in 2018 it was the world’s largest at USD 294 bln representing 7.4% of GDP, down from 2015’s 8.9% but still way above the European Commission’s upper bound of 6.0%. Given the EU area’s GDP surplus is a tad below 3% it’s patently obvious that Germany’s out-performance is robbing economic vibrancy from fellow EU members, particularly those currently in the Euro Zone.

In the past the less productive economies would devalue their currencies to offset Germany’s efficiency gains, without that ability Germany’s economy will continue to outpace fellow EU member countries and the economic imbalances will continue to compound. A more egregious current account surplus offender in percentage terms is the Netherlands at roughly 9% but due to Germany’s larger population, it is Germany’s current account surplus that draws the attention.

The US current account deficit last year was USD 488.5 bln or 2.4% of GDP, it’s unhealthy to continue to amass these sizable deficits which is why the US Administration is fighting to redress trade imbalances after decades of deterioration. Wealth transference between the G7 and the rest of the world has continued unabated for decades but it’s only the primary G7 C/A deficit nations that suffer at the margin.

Global central banks, still recovering from the Great Financial Crisis remain handcuffed in their ability to accelerate global growth the RBNZ held rates unchanged this week after no changes from the BoC, BoE, BoJ, RBA and the SNB. The 25bp rate cut by the Fed and further 0.1% increase in the ECB’s base rate paints a grim picture as to next steps. The pundits believe the negative US yield curve forecasts that a US recession is on the cards but US economic data does not support that theory.

Whilst the US ISM dipped into mildly negative territory (49.1) it was the August report and that’s when factories shut down and retool. Depending upon the vagaries of those developments (Did they extend the furlough? Did the dates straddle different weeks because of calendar effects? etc) it’s not a good month to base decisions on.

US industrial production was +0.6%, decent; retail sales +0.4%, OK; durable goods +2.1%, nice headline; housing starts +12.3%, outstanding; housing sales +1.3%, good; and house prices are up on the year. Add to that average hourly earnings are up 3.2% despite a softer set of NFP data than forecast, plus downward revisions and you have to say things are OK. not great but OK.

On balance it appears the Fed’s actions for once have been to head off potential headwinds to the economy. With unemployment at a historically low 3.7% it surprises me that we’ve had consecutive rate cuts but we have. Those cuts were insurance cuts, ’cause nobody wants a recession, you can always hike if the inflation rate accelerates but with negative interest rates in most of the developed world what’s going to ramp up inflation?

The biggest potential black swan event is likely to emanate from the continuing trade tariff discussions between the US and China (mainly) and the EU behind that, but these discussions are needed to redress negative trade conditions that have prevailed for decades, with China and Germany the largest global export rivals and both of their trade surpluses, the Administration will continue to fight the fight.

The fact of the matter is the US sucks in the most imports, in a tit-for-tat war on trade tariffs, the US has to win. Sure the US consumer may have to pay a little more for consumer goods but it could also have a positive impact domestically, US consumers may buy more American products as foreign price advantage is diminished by tariffs; but maybe they’ll decide at the higher price it’s not worth having. Either way the US capital accounts will eventually benefit.

TRIP NOTES

My traveling companions and I visited Croatia, France, Greece, Ireland, Italy, Spain and the UK. The tourist trade is alive and well and the relatively cheap EUR/USD rate has tempted US tourists to revisit the old centres of commerce and culture. We avoided most capital cities as we were trying to tap into the psyche of populist politically leaning swing voters who have turned the world on its ear over the past four years.

We wanted to know whether or not those sentiments survived after the disillusionment that has set in as politicians either side of both the Atlantic Ocean and the English Channel have failed to deliver on promises made back then. Partisan politics in the United States have vexed the Administration and diluted many initiatives, thus the country remains as schismatic as it was in 2016.

In the UK Brexit has been debated, delayed, deferred, and currently – derailed. The likelihood of a “hard Brexit” appears greater today than ever but the political will to expedite a more palatable solution remains absent in the island nation. On the other side of the channel EU politicians cling to the hope that the British people will rescind their decision and for their part have refused to offer a reasonable solution, mainly due to the cost of Britain’s share of the EU budget that will fall on the reluctant shoulders of the other EU members.

Brexiteers, largely the populace outside of the capital and south of the Scottish border, remain frustrated by the lack of available jobs and what they consider over-generous facilities offered to immigrants upon arrival in the country. They complain about long waits for what are routine health issues because the national health service is overwhelmed by the most recent wave of immigration.

In Ireland, Dubliners are concerned about commerce being interrupted by a no-deal Brexit. Taxi drivers having enjoyed a strong uptick in tourism in recent years are worried tourism in the Irish capital will contract if we see a hard- Brexit.

The people in Galway fully expect a hard border to be reinstated and cite commerce of fishery products (which are primarily exported to the EU) as a likely area for disruption. The current distribution channel has Irish fishing boats offloading their catch in Wales at the port of Holyhead. From thence the fishery products are shipped by road to ports on the south and east coast of England to be shipped to the EU.

It’s the fastest route to ship the product but any post- Brexit red tape would cause delays, delays would impact the freshness of the day’s catch and threaten viability of that trade route. Ireland being an EU member has the right to want to insulate this source of export income from disruption, therefore the EU needs to work with Ireland to help it through any Brexit disruption.

If sealed containers were filled in a tariff free border zone in Wales and then shipped across the UK for re-export to the EU it would resolve the problem but European politicians have shown little or no interest for these types of solutions. All they want is the UK to kiss and make up with the EU and continue with “business as usual”.

Neither the Northern Irish or Scottish politicians are pro Brexit and if a no-deal Brexit threatens their local economies they have some tough decisions to make including the potential of seceding. More importantly, break up of the United Kingdom would dampen risk appetite globally and would likely throw the global economy into a severe contraction. That wouldn’t help anyone.

The intricate and intertwined trade ties between the individual countries that make up the UK and Ireland make Brexit a logistical nightmare but the British people voted for Brexit because of the heavy burden that the recent wave of immigration has levied on the social support networks and health care systems.

When we visited London we never met anyone in the service industry that was a British citizen until we’d been in the country for a day and a half. It was a similar story in Dublin although Galway had a more defined local presence. One of the biggest complaints English Brexiteers have is the lack of job opportunities for their children who are now young adults.

When we were in Rome there were similar complaints about migrants having unfair advantages to locals, so these issues are not confined to the island nations west of the English Channel. There were rumbles over the relationship between Italy’s government and the EU, particularly over budgetary issues but Italy’s political scene has been a mess for many a year and it didn’t seem that the populist voice in local politics was threatening to boil over.

We traveled the countryside and tourists spilled out of tour buses and off ferries on the Amalfi coast. Even in the middle of Tuscany, tour buses from cruise ships docked at the local port of Livorno carrying largely American tourists into the Medieval towns, villages and vineyards in the mountains. In the port of Livorno we also noted strong signs of the regional industrial base with several hundred, perhaps a thousand cars waiting dockside to be loaded onto container ships. In Naples we saw similar signs.

In Barcelona the issues were not specifically job related, frustrations seemed more focused on how recent demands for greater autonomy for the regional government were handled by Madrid. Other than that, the city is enjoying a tourist boom as cruise ships laden with American and Japanese tourists invade the city with the almost completed Sagrada Familia cathedral a popular draw.

Our trip to France was off the beaten track, Normandy was enjoying a surge of visitors for the 75th anniversary of D’Day. We stayed in the area for 5 days and noted the holiday atmosphere as the French Citizens celebrated their liberation and dress in the uniforms of allied military personnel and nurses. It was a moving experience and the French people were very hospitable. Political concerns focused mostly on recent violence in Paris and related security issues

We also visited Marseilles and like Livorno and Naples, was teeming with industrial activity, suggesting there are pockets of strength in the EU manufacturing economy but overall the outlook remains repressed by weak local demand.

Our other ports of call were Croatia and Greece (Corfu) tourist havens also buoyed by the cruise ship business but not a good yardstick for either populist politics or industrial activity. Whereas Croatia seemed devoid of any immigration issue there were some local problems in Corfu that raised comments regarding the influx of migrants.

Back in the day when the EU countries had their own currencies, Italian Lira, Spanish Peseta and Greek Drachma would all strengthen under the weight of tourist inflows during the summer months. The inevitable devaluations against the DEM always arrived after tourist season ended and prior to the next tourist season beginning.

This effect probably helped EUR/USD sustain the 1.11-1.14 ish range through the summer. The ECB rate cut has put downward pressure once again and now that the Northern Hemisphere’s summer has drawn to a close, the impact of tourist inflows will subside.

Pressure on GBP due to the Brexit mess and talk of USD liquidity tightness in Q4 (recent JPM comments highlighted in Zerohedge) are other fundamental reasons EUR/USD could see more downside.

May the Forex gods be with you

Peter

Categories Uncategorized

Leave a Reply

Please log in using one of these methods to post your comment:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s

This site uses Akismet to reduce spam. Learn how your comment data is processed.

%d bloggers like this:
search previous next tag category expand menu location phone mail time cart zoom edit close