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.
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 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.
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.
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.
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.
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