Reviewing Market Carnage 2.0

Back in the middle of October last year, I wrote an article to summarize and explain the Market Carnage. It was never published on my blog, therefore I added it in the Appendix section. This morning, it seems that we experienced another ‘Black Monday’, triggered by some disappointing news coming from China. The PBoC surprised the market with no RRR cut (while a 50-100 bps cut was ‘expected’ by the participants), and then followed a market collapse with the Shanghai composite down as much as 9% at one point (the most since 1996). US Equities were down as well, trading below 1,900 as you can see it on the chart below, while USD/CHF (blue line) is down 5 figures in one week flirting with the 0.9300 level when I was writing the article.


(Source: FXCM)

I personally believe that you can learn a lot from a trading session like today, that tells you that the market can go anywhere. While the sell-side research was telling me that EURUSD has nowhere to go but down and that US 10Y rate will never go back below the 2% level and that it could be interesting to start buying oil at $40, last week’s session and today in particular prove you that you can have it all wrong. One thing that I am ‘happy’ to see is that the Swissie has really acted as a safe haven currency, something that I understood after the SNB removed the EURUSD floor on January 15th (and consider it as a historical event).

Volatility was considered so high that the NYSE invoked ruled 48 to avoid a panic selling at the US Opening. The rule, approved by the SEC on December 6 2007, says that market makers ‘will not have to disseminate price indications before the bell, making it easier and faster to open stocks’.

Insane moves were seen on the currency market, to begin with NZDJPY that totally collapsed from 81.50 to 72.50 earlier today (that’s a 11-percent move in a single day!). USDJPY registered a 6-figure move down to 116 (mid-January lows), and EURUSD went North breaking the 1.17 level and gaining 300 pips in hours with a huge lack of liquidity (See Chart 1).

Reaction is expected now from China in order to calm down investors, and hopefully bring the situation back to normal. I am sort of convinced that the situation will stabilize within the next couple of days, however those market flash crashes kinda worry me about the global macro situation in most of the countries. As I mentioned it in some of my previous articles, I am persuaded that the Fed is not comfortable with those types of trading sessions. Coming now to the September hike, it is much less obvious that US policymakers will start a tightening policy based on the market’s attitude on trading days like today.

The question now is: ‘What sort of tools has China got in its advantage to calm this ‘panic’ (and the BoJ and SNB) in the coming week?’ I am currently working on a article about China’s economic and financial situation and its relation to the commodity market that I will try to publish soon.

In my current FX positioning, I am long USDCHF at 0.93 and short EURUSD at 1.1665 as a believe we will see a calmer afternoon.

Chart 1 (EURUSD)


(Source: FXCM)


For the past few years that I have been trading, I believe Wednesday was by far the most volatile and swingy session of all. It first started very quietly in the UK morning session, and then it really went out of control before the US opened. I don’t even know where to begin…

Equities continue their correction: Eurostoxx 50 index is down more than 12% (French and German market are off 12.5% and 13.5% respectively), the Footsie and the S&P 500 both down by 9.5% since the highs reached on September 19th.

If we have a look at the chart below, we can see that the VIX, which measures the 30-day volatility implied by the ATM S&P500 options prices, surged and breached the 30 level and is now trading back to November 2011 levels, taking the equity (S&P) down with him. There is clearly more room for further correction, no buy-the-dip scenario this time unfortunately.

SPVIX(Source: Reuters)

One currency that continues to strengthen in reaction to the risk-off sentiment (a real one this time) is the Japanese Yen. After the nice August/September momentum, USDJPY, which reached its peak of 110.08 on October 1st, was sold to 105.21 in the early afternoon before recovering back to 106.00. Our favourite [carry trade] pair keeps tumbling and is now trading at a 7-month low slightly below the 93.00 level. As I usually say ‘it is all about the Yen’, you better watch carefully where the currency is going at the moment [more strength!] as it will give you an idea of the overall market.

Another big ‘surprise’ was of course the 10-year US yield (blue line) that tumbled below the 2% level down to 1.86% approximately (May 2013 levels), before ‘recovering’ to 2.1%. I always ask myself ‘where does the market like to see the 10-year yield?’ Obviously not too high, but below 2% clearly means that the market participants are not confident [at all]. On the other hand, Gold (yellow bars) continued its rally, up to 1,250 before edging lower to 1,240. The 10-minute-period chart below (USDJPY in red bars) shows you that asset classes moves clearly ‘together’ under a ‘stressed market’.

GOldYenYields(Source: Reuters)

End of POMO, what to expect from the next FOMC meeting (October 28th)?

While we are ‘kindly’ approaching the last days of QE with the Fed stepping out of the bonds market at the end of this month (October 28th, see chart in appendix), I think we may have a couple of dovish FOMC meetings concerning the central bank’s ST monetary policy. To me, it looks like the US policymakers have made a ‘mistake’ by expressing themselves on that point [rate hike] as they should have let the market swallow a period without QE. True, Fed officials are willing to start tightening. For instance, we heard San Fran Williams (one of the most dovish and apparently seen as a good ‘barometer of the views of Yellen’) saying that he would hope the Fed can tighten, mentioning 9 months to see the first hike. However, it looks to me that the higher rates world is just an illusion…

In order to avoid the ON/OFF calls that we have seen since the beginning of the year (RBNZ, BoE and now the Fed), there need to be a sort of global monetary policy coordination. Otherwise, we are going to see other sharp fluctuations and especially in the FX market (remember, nobody wants a high exchange rate, not even the US, aka the Fed).

On the top of that, oil is plunging; coincidence? WTI November 2014 futures contract is now down more than 20pts since June trading slightly above 80 (as Zero Hedge mentions: ‘if Oil plunge continues, now may be a time to panic for US shale companies’). As I believe that Oil prices and the equity market are the Fed’s two most important components, I don’t only see cheap oil prices only as a benefit (stimulus) for consumers, therefore adding pressure on Yellen’s [and Co.] team.

My view goes for a Dollar pause, and I will carefully wait for the October (28th) FOMC meeting to see how US policymakers are going to deal with the current situation. An important figure to watch will be the Inflation report next Wednesday. US CPI is expected to remain steady at 1.7% YoY in September, however I think we could see some disappointment…

Unknown(Source: NY Fed)

The ‘Obama’ Dollar Rises…

Over the past few weeks, I had several discussions with some friends of mine to try to understand and clarify the US Dollar ‘pause’ we have seen since the middle of March. A dovish stance from the Federal Reserve, which obviously led to a status quo at the June FOMC meeting, may have halted the Dollar bulls, but it seems to me that the market is getting more and more confident about this year’s lift-off.

Based on the forecasts made in June, the Fed Staff expect policymakers to raise the Fed funds rate to 35bps by the end of the fourth quarter of 2015, which implies a one quarter-point hike this year (chances of an initial move at the September meeting stand roughly at 60%).

Quick recap’ on the macro figures

Even though the unemployment rate hit a 7-year low at 5.3% in June (with a strong NFP at 223K) and Q2 GDP came in at 2.3% (above the 2% ‘target’, but still below Wall Street’s consensus estimate of 2.5%), the rest of the figures and the overall macro/geopolitical situation both don’t look quite good. US inflation has average 0% since the beginning of the year (0.1% YoY in June), consumer spending YoY declined for the third consecutive month and both business fixed investments and net exports stayed soft. On a broader scale, the commodity-meltdown continues as demand from China may slow even further on the back of a weak manufacturing activity (Chinese PMI fell to 47.8 in July, its two-year low). For instance, NYMEX WTI September futures are trading near levels not seen since March, with September contract at $46.30 per barrel.

In addition, even though the Economic and Financial Affairs Council (ECOFIN) approved a 7.1bn-euro bridge loan to Greece last month (July 17th) given through the EFSM so that the country could meet its short-term obligations including a 3.5bn-euro payment to the ECB on July 20, Athens has no money left. That is problematic as a second big 3.2bn-euro payment is coming on August 20 to the ECB and there are talks that they may miss it as the bailout timeline is ‘unrealistic’.

Chinese economic slowdown, low oil prices, deflation and Greek payments are all subjects that I try to follow closely as it is the topics I believe that US policymakers are watching as well. However, I think this time the Fed officials are quite ready for a lift-off in September, and now I have been questioning myself about the US Dollar rally.

The Dollar Rallies…

The chart below shows the three dollar rallies that occurred since the collapse of the Bretton Woods system. The first big one is the Reagan dollar rally in the early 80s, fueled by the tight monetary policy. As a result of the second oil shock in 1979, chairman Volker orchestrated a series of interest rate increases that took the federal funds target from 10 to nearly 20 percent. If the Euro had existed then, the single currency would have depreciated by roughly 60%. The rally was eventually halted in September 1985 by the Plaza Accord signed by five governments to depreciate the US Dollar in relation to the Japanese Yen and the Deutsche Mark.

The Clinton Dollar rally started in the mid 90s fueled by the US Tech bubble and capital inflows into the US equity market in addition to the US government running federal surpluses. This surge brought the Euro down to 0.8230 against the greenback and USDJPY was trading at a high of JPY135 at the end of the rally (late 2001).

The recent Obama rally has started in early July last year as a result of monetary policy diverge between the US and the rest of the World. The commodity meltdown will continue to weigh on commodity currencies and especially on the Dollar-Bloc (CAD, AUD and NZD), as Greece will continue to make the headlines until Bailout#3 is eventually agreed.

As you can see on the chart below, I added a downtrend line that was broken in the beginning of the year. The US Dollar index hit a high of 100.80 in mid-March before its March-May consolidation. It looks to me that the greenback is gradually recovering from its quick contraction.

DXY avec MA

Source: Reuters

Despite a low volatile market at the moment, I am convinced that the US Dollar will gain strength in the end of this second semester. I will try to add a currency-detailed article by the end of the week with my new levels on the main currency pairs.