What does Q4 hold for dollar, key markets?
Report prepared by Ahmed Shibley
The third quarter has drawn to a close with remarkable levels of inactivity despite an abundance of trends from key benchmarks. In the capital markets, the S&P 500 charged to a record high on an eighth consecutive quarter climb while the VIX volatility index slid back below 10. Other, global equity indexes may not have enjoyed the same degree of productivity, but they were broadly higher. Meanwhile, in the FX market, the Dollar slid to two-anda-half year lows while the Euro soared to equivalent highs. What motivated these moves matters profoundly for trends heading into the final quarter of the trading year.
Heading into the fourth and final quarter of 2017, speculative appetite and a shift in global monetary policy will continue to determine the bearing and activity level of the financial system. The Federal Reserve has revitalized rate expectations; but the Bank of England’s and Bank of Canada’s policy forecasts carry more hawkish expectations. As for speculative reach, exposure is at unprecedented levels both for both key measures like US equity indexes and through nascent rate forecasts for major currencies.
The Dollar took a bit of a breather into the final weeks of the third quarter, but the trend for the year is still overwhelmingly bearish. Through the year, the currency (on a tradeweighted index basis) has dropped as much as 13 percent. That is a remarkable pace for an asset as liquid as the Greenback and given the general nature of restraint that has define the global financial markets. Yet, there was strong fundamental motivation behind this tumble. The distinct turn in broad monetary policy away from limitless easing to ‘normalization’ removed a distinct advantage that the currency took advantage of in previous years. That said, expecting an unfettered bear trend from a currency whose fundamental backdrop is otherwise robust is a stretch.
While other central banks are looking to slowly close the gap on monetary policy with the Fed, the US currency’s own bearing is not running in the opposite direction. At its September gathering the central bank retained a forecast for another hike in 2017 as well as further tightening in 2018 and beyond. Few others can claim this outlook. Furthermore, the group signaled the start of its QE reduction effort which not only reads a material escalation in policy reversal, it holds practical implications for market rates. The US may not be the only region tightening, but it still maintains an advantage in pace and timing.
Another aspect to consider for the Dollar moving forward is its deprecated position as a safe haven. There has been little need for an absolute harbor from risk given the flush conditions in the financial system. Yet, those green times cannot last forever. In 2017, the currency started to deviate from its faux carry trade appeal (as previously the only currency to see its benchmark return rising), but that may actually reduce its exposure to risk aversion should it rise. It could further stage a more appealing outlet for safety should that need finally return. Yet, the catalyst for fear is always important. A government crisis, protectionist crisis or the start of a US-involved war with North Korea could degrade a haven label. There are changing dynamics and dramatic technical to consider with the Dollar when projecting our trading plans for the fourth quarter.
Once again, the
British Pound shrugged off the dire predictions of analysts worried about Brexit and a chaotic political situation in the UK to climb against the US Dollar in the third quarter of 2017. Boosted by a growing conviction that UK monetary policy was about to be tightened, it continued to make headway - admittedly helped by the persistent weakness of the Greenback - and in the fourth quarter, there’s no reason to expect that to change.
However, the technical outlook does not look as rosy as the fundamental picture painted. There is a cluster of wave relationships and resistance forming from about 1.37 to1.39. Therefore, GBP may have a fundamental advantage over many other currencies, but GBP/USD is ripe for large trending move lower.
Moreover, if the UK Government collapses completely and a new General Election is called and won by the Opposition Labour Party, the Pound would undoubtedly suffer.
In the rearview mirror lies an impressive quarter for the price of Crude Oil. In September alone, Crude Oil price rose by nearly 9%, and much of the move higher was a combination of fundamental shifts from both the IEA and OPEC demand forecasts. The raised demand forecasts align with the production curb from all but two OPEC countries makes the argument that the diligent rebalancing effect is working.
In addition to rising demand and the reduced production from OPEC, traders can look to physical markets, which are encouraging. The rise of backwardation, where the front-month contracts trade at a premium to later deliveries signaling tighter supplies in encouraging for the market. Such a development is fundamentally bullish as it shows the time premium on getting access to the commodity sooner than later. In addition to the price of Crude Oil itself, backwardation tends to be a positive development for energy derivatives like energy-based shares.
If the backwardation structure continues into Q4, traders could expect to see Bullish price patterns play out. Later in Q3, Brent Oil traded close to $60/bbl, and further backwardation may push the price through $60 in Q4.
The Japanese Yen has bossed the greenback for much of 2017 but looks set to struggle as 2017 fades to black.
The fourth quarter’s start line finds the US Federal Reserve firmly inclined raise interest rates further, assuming the economic data let it, and to start winding down its crisis-bloated, $4.5 trillion balance sheet. Meanwhile the Bank of Japan remains tightlywedded negative base interest rates, control of the Japanese yield curve to keep ten-year yields near zero and a massive bond-buying program. In other words, the monetary taps are wide open in Tokyo and likely to remain so, possibly for years.
Indeed, there is one member of the BoJ’s policy board who last month said that even more stimulus would probably be needed to hit the central bank’s target - consumer price inflation sustainably around 2% (a very long way off from the current 0.7% rate). Former Mitsubishi UFD economist Goushi Kataoka appears to favour even looser settings. He stands alone on that, but the BoJ’s committee remains an extremely dovish group.
Against this backdrop USD/JPY looks set to rise, assuming risk appetite holds up and conflict between Pyongyang and Washington DC remains confined to the verbal and diplomatic. The procession of US taxreduction proposals through Congress will also be closely watched. Logjam there could set the US Dollar back, but a relatively smooth passage would be sure to lend support.
In short however, interest rate differentials are back in charge and, for as long as they are, the Yen is going to have a tough time. And not just against the US Dollar. After all, some degree of policy tightening is now in the mix for the European Central Bank, the Bank of England and the Reserve Bank of Australia as well as the Fed.
Gold prices may exhibit a more bullish behavior over the remainder of the year as Federal Reserve officials adopt a less-hawkish tone and project a shallower path for the benchmark interest rate.
Even though the Federal Open Market Committee (FOMC) appears to be on course to deliver three rate-hikes in 2017, Chair Janet Yellen and Co. now forecast a terminal interest rate well below 3.00% as ‘overall inflation and the measure excluding food and energy prices have declined this year and are running below 2 percent.’ The downward revision in the longerrun interest rate forecast suggests the FOMC is inclined to halt the hikingcycle ahead of schedule, with bullion at risk of exhibiting a more bullish behavior especially as it breaks out of the downward trend from 2012.
Last quarter we noted that while the broader outlook for gold prices remained constructive, “the risk remains for a material set-back before resumption of the broader up-trend,” with our bullish invalidation level steady at 1209. Indeed the first week of the third quarter saw prices come under considerable pressure with gold rebounding sharply off (low registered at 1205) support and is poised to close the third quarter up more than 5.3%.
The subsequent rally and breach above slope resistance extending off the 2016 highs kept the long-bias in play with the advance reversing of channel resistance in early September trade. Interim support rests at 1295 with our broader bullish invalidation level now raised to 1240.
Gold prices could still see some downside early in the fourth-quarter but the focus remains higher while above 1267.
Global equities accelerated upward in the third quarter, and investors can be forgiven a rosy disposition: most of the would-be headwinds lining up to derail gains at the beginning of the year have dissipated. At least from a market sentiment perspective, a worrying election cycle in Europe passed largely without incident. Meanwhile, the global economic growth dynamics tangibly improved.
Caution seems warranted however, as market exuberance approaches familiarly heady levels. The pricing of risk in the bond market is at multidecade lows. Worryingly, it had fallen to these very levels on the eve of the Great Recession. If investors are feeling as cavalier now as they did then, might they allow errors that lead to a similarly catastrophic outcome?
From a technical perspective, the long-term uptrend seems to be firmly intact. The benchmark S&P 500 index is seemingly poised to find itself higher at the end of the fourth quarter than it was at the beginning. As with the fundamental picture however, this too is not unqualified. Indeed, the chart setup is offering a glimpse of pivotal areas that in time might emerge as the place where the tide ultimately turns.