Fragmentation – Plenty of Opportunity!
Fragmentation Means Plenty of Opportunity! – Jan 29
The markets are becoming increasingly fragmented.
Markets do not always move together at the same time but they do normally tend to keep some sort of correlation or coherence in the near term (ie one month). However their cohesiveness continues to break down in 2017. This suggests firstly certain established trends are close to completion and reversing and secondly that there are significant cross or spread opportunities in the shorter term.
At the start of the year we explained how traditional inter market relationships frequently break down for 2-3 weeks as traders seek and over pursue different early year trends. However, this has persisted for the whole month of January and suggests the major prevailing trends lack breadth (ie they are often moving in isolation or isolated groups) and therefore will not be sustained.
This is particularly true of the stock markets that have seen some Indices rally strongly but not others. The DJIA, SPX, DAX (and possibly soon Nikkei) have all enjoyed new highs following Donald Trump’s Inauguration (and the Trump Fractal). But it appears the Russell, FTSE, and the French CAC have been refused admittance to the party. We doubt this break down in correlations (fragmentation) will last long. In fact many of the correlations are delayed eg Nikkei leading the normally lockstep USDJPY by 36 hours. But it does suggest the causes of the previous post Election uptrend (eg rotation out of bonds into US stocks) no longer have the same breadth and therefore no longer have the same force to sustain the move. This is supported by the continued similarity to the 1929 and 1987 blowout and crashes as evidenced by the (even now fragmented) countdown to a major DJIA top To keep abreast of how this blowout is developing continue to check http://www.matrixtrade.com/freemembers/
It is also true of the uptrend in the key US 10 year and other associated yields (Bunds). Correlations will return to normal (ie fragmentation end) when the markets turn. Indeed yields have also entered the last leg of (at least) the initial uptrend} projecting a reversal in both yields and stocks soon.
The result of this fragmentation has most keenly been felt by the USD. If you went by the Forex market alone you would not think we lived in a Trump dominated world. Both GBP and EUR went in opposite directions this week. But the greatest evidence of a fragmented short term market comes from the USD-US Yield relationship. The correlation hasn’t gone away. It was just delayed by 136 hours..
Correlations will therefore only return to normal (ie fragmentation end) when the markets turn. Although yields have also entered the last leg of (at least the initial uptrend) projecting a reversal in both yields and stocks soon this will probably not translate into a universal reversal in the typically lagging Dollar.
It is beyond the remit of this newsletter but not the writer to wonder whether Donald Trump is more likely to cause fragmentation than division. In other words what we are seeing now in markets may not be temporary. However, this does create more opportunity in the shorter term particularly in the area of ‘staggering fractals’ – where markets repeat each other with a delay. Take advantage while it lasts.
“However fragmented the world…. it is an inexorable fact that we become more interdependent every day.” Jacques Yves Cousteau
In President Trump’s first week in office overall continued the trend from last week of indices rising higher whereas DXY had a V-shaped week, finishing roughly flat.
In the absence of news on Monday, the week started with a typical post Trump event disappointment as the market sought confirmation and detailed of the expansionary election rhetoric. In the Asian session, NKY fell (as did USDJPY as usual), and NIFTY gave up a brief ramp. The trend continued into Europe with DAX falling 1% on the open, and SPX falling 0.6% at the US open, although some ground was recovered by the end of the day, as it was with oil.. FTSE’s volatility was much less. It ended flat for the day and indeed all week, consolidating inside a 1% range. EUR, AUD and gold were similarly flat, CAD rose slightly. GBP, this week’s most volatile currency rose constantly all day to put on 1.5c (1.2%).
Tuesday was a day of two different sets of expectations. In Europe, the UK Supreme Court ruled against the UK government pursuing Brexit without a parliamentary vote. This overshadowed the UK PSBR beat at 0930. As this was universally expected, it provided the classic buy the rumor sell the fact, before GBP rallied again because many expected the post ruling sell off. This is a common case of over-anticipation in markets- The Double Whammy.
Tue 24 (Continued)
After the previous 6 days of ranging and the Monday Trump disappointment sell off, the market did not expect and was caught off guard by a resurgent stock market assisted by a recovery the day before in US yields. The European session bought USD against EUR and AUD, but the positions reversed in the US session after a PMI beat at 1445, when SPX sharply rose all day as much as 19 points (0.84%) before giving up a little at the close. Other indices joined in, and EUR and AUD, and particularly CAD ended the day higher as well. Gold started a decline which lasted all week.
Wednesday was a blowout. It saw Japanese, German and US stocks and bond yields rally aggressively following the now well established post-Trump template. However this was not uniform with FTSE and CAC and most surrogate currencies ignoring this uptrend, except CAD which hit a weekly high (USDCAD low) of 1.305, before fading slowly for the rest of the week. This was despite a flat day for oil, ignoring the EIA miss at 1530. GBP resumed its upward trend, probably part of the reason why FTSE faded. In recent weeks, the momentous Trump world has meant the economic calendar has had less effect than usual. We told you last week about the two other events that topped and tailed Wednesday (in GMT). It was therefore almost gratifying to see the slight miss on Australian inflation at 0030 cause an instantaneous 50 pip (0.7%) spike down, increasing to 1.1% by the end of the Asian session. Similarly the NZ CPI beat 21 hours later caused an NZD 0.55% spike up, after an instantaneous flash spike down of 0.3%. The Kiwi could couldn’t hold the gains, and had faded 1.24% to 0.7222 by the end of the European session on Thursday, exactly where it started in Europe the day before.
On Thursday, correlations continued to skew. Stocks that are taking part in the post inauguration rally maintained their gains (FTSE RUT and CAC are not at the party) and the USD finally reacted to rising yields, rising across the board. Even GBP took a breather, and actually faded the GDP beat at 0930 by 111 pips (0.88%), only reversing at the US Jobless Count miss at 1330 (which had little effect on other pairs). The market is being driven by flow not the textbook. Oil rose sharply in the early US session, putting on 2.3% in a couple of hours for no particular reason. However it gave up the gains in three spikes down the next day.
The Japanese inflation miss (2330 Thursday) slightly weakened the yen on Friday, pushing USDJPY to a weekly high of 115.37 by 1330.. EUR, AUD and gold made small recoveries both still well down on the week. Conversely bond yields gave up some of the gains from earlier in the week. Indices were largely flat on the day as they consolidated their (very small in the case of FTSE) gains.
Next week clearly has potential to be volatile. Any day soon Donald Trump is likely to table the end of NAFTA (North American Free Trade Agreement). Although the outcome of what are likely to be prolonged negotiations will be unclear for a while, history has a very interesting precedent. We find many of the best instances where markets repeat themselves through logic rather than human or programmed scanning of markets. It may not be a surprise but it is certainly amazing that USDCAD is repeating the same price action as CADUSD during the negotiations before the start of NAFTA during the 1990-1992 period. We will continue to track this price action closely. Indeed a shorter term magnified version is available to subscribers on our USDCAD page.
Even without any NAFTA announcement, the week promises to be very busy indeed. The weekend is already full of politics, with the German SDP picking their candidate to run against Angela Merkel in December, and the second French Socialist primary. The outcry over the Trump Muslim ban’s effect on tech giants remains to be seen. We have three rate decisions this week, including the all-important US Fed, the first such decision in the Trump Presidency, and the first time since November that the rate set and NFP are in the same week. Trader are expecting a hold at 0.5%, but the ‘dot-plot’ will reveal future intentions. You can see probabilities change on a daily basis with this useful CME Group tool http://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html
Monday is relatively quiet with German inflation at 1300 and US Consumption at 1330.
The Tuesday Asian session opens with the BoJ rate decision at 0200. Although the -0.1% estimate, unchanged for over a year, is highly likely, previous events have shown yen volatility. The press conference is later at 0630. As we have seen with EUR, that may generate more volatility than the rate itself. Indeed, since USDJPY continues to mark out very similar but smaller scale price action to the whole of 2015-2016, the heightened volatility represented previously by the US Election day provides an excellent possibly two way trading opportunity. We will certainly be around looking to trade and issue trading signals through what would well an exciting session. This and a much magnified version of this chart will be available by Monday close on our USDJPY analysis page.
The European session see Eurozone GDP and inflation at 1000. As this is a combination of all 19 Euro countries, only a big departure from the estimates of 1.7% and 1.4% would affect the single currency. The UK government starts the Brexit debate they were forced into by last week’s court ruling. GBP may be volatile again this week. Finally we have Canadian GDP and some PPIs at 1330, normally of little consequence, but worth watching as CAD has been volatile recently, and also Governor Poloz releases a speech an hour before the figure. Sentiment is improving on the Keystone Pipeline news, and as Trump’s fire is pointed at the other NAFTA partner, Mexico.
Manufacturing PMIs are reported for four countries on Wednesday: China at 0200; Germany at 0855; the UK at 0930; and the US at 1500. All are well over 50 (the point between contraction and expansion, equivalent to the zero point on GDP, CPI etc.) so no big moves are expected. The Chinese data reaction may be muted, as the stock exchanges are closed all week, and are therefore unable to give a lead to other Asian markets. More Brexit fun as UK Trade Secretary Fox is questioned by the British parliament’s trade committee. As always in NFP week, we get a hint to Friday’s figure with the ADP Payrolls figure. The estimates are very similar (168k ADP, 165k NFP), so a substantial beat or miss will move markets. However, as stated above, the big news of the day is the Fed rate decision at 1900.
The UK is in the spotlight on Thursday as well. The rate decision is at 1200, and unlike other countries, the UK publish how many of the MPC voted for an change. After the UK Jan 17th inflation beat, there is a small possibility that it won’t be 9-0 this time. Even one vote to raise (usually McCafferty) could raise GBP. The BoE has form on this, they didn’t implement a widely expected cut last July. Otherwise we have US Jobless Claims at 1330, and BoJ Minutes are due at 2350.
China has more Manufacturing PMIs at 0200 on Friday, just before the markets re-open after a week. The equities gap will be worth noting, as plenty has happened in the world in the first week of the Year of the Rooster. The big event of course, is NFP at 1330. As usual we will be employing our traditionally accurate fractals across a number of instruments.
EVENTS (high volatily in bold)
1300 German CPI
1330 US Consumption
0200 Japan Rate Decision, consensus hold -01.%
0630 BoJ Press Conference
1000 Eurozone CPI and GDP
1330 Canada GDP
0200 China Manufacturing PMI
0800 ECB Meeting
0855 German Manufacturing PMI
0930 UK Manufacturing PMI
1315 ADP Payrolls
1500 US Manufacturing PMI
1900 US Rate Decision & Minutes
1200 UK Rate Decision/QE/Votes
1330 US Jobless Claims
2350 BoJ MPC Minutes
0145 China Manufacturing/Services PMI
1330 US Non-farm Payrolls