A traders playbook - another defining week in the making

25 Eyl 2022

After a defining week in financial markets we look forward to a noise fest from individual central bankers – on first blush, I count 22 Fed speakers, 30 ECB speakers and 6 BoE speakers all out on the wires this coming week. Strategically, it's hard to see them diverting too much from the central bank statements that inflation must be put to bed, and there will be pain along the way.

Certainly, the BoE is where many will be looking to and they could offer new intel as the GBP is the whipping boy of G10 FX and the UK bond market is getting smoked – the funding requirement needed to pay for the ’mini-budget’ means either we need to see far better growth or higher bond yields to incentive capital inflows – with such a ballooning twin deficit consideration the GBP has been punished and taken to the woodshed, falling close to 5% on the week.

The next BoE meeting is not until early November, and the market feels we see a monster 100bp of hikes at that meeting – the market is searching for a response to address the new fiscal uncertainty and that makes speeches from the BoE this week so important. Talk of supporting the UK bond market through increased channelling of private savings is making waves, while traders are betting the BoE will also need to cut off potential demand driven by tax cuts, possibly with an inter-meeting hike – either way, targets of sub-1.05 in GBPUSD are being liberally thrown around and while grossly oversold, one suspects any rallies in cable will be sold.

While we watch the Fed’s balance sheet reduction in earnest, the Fed all but announced a recession last week – you simply can't take your unemployment projections up nearly 1ppt to 4.4% and not see a recession as the consequence. As everyone has witnessed, the USD reigns supreme – it's in beast mode and has everything working for it – carry, momentum, relative growth and the primary portfolio hedge. If the USD is rallying central bank balance sheets are falling and this means lower liquidity and that is impacting broad financial markets. The question we ask is what turns this flow around?

For me, while USD positioning is rich and the greenback is overbought, the investment case for the USD is even more compelling now than it was 2 weeks ago!

Everyone is looking for the central bank put to kick in – the fact is central banks have made it clear that we’re some way off from a signal they will take their foot off the breaks and markets know this – personally, I am looking at the US Treasury 2s v 10s yield spread – at -52bp the curve is telling us a recession is coming, but its when we see US 10yr Treasury yields actually fall with buyers really wading in, that we can price a turn in the USD with greater conviction. Consider that US 10yr Treasury yields have gained for 8 straight weeks – can we see a 9th? US 5yr real rates gained 46bp on the week and again this is putting a strong bid in the USD – the Fed should welcome higher real rates, as its tightening financial conditions and if they are serious about fighting inflation, which they are, then we should expect higher rates.

We can talk about mobilisation in Russia, and a globally coordinated rate hike to the collective tune of 600bp, but amid an incredible week, the BoJ intervention was a standout for the market. A 5 JPY move on the day will have JPY shorts thinking twice about their positions, and that sort of move really hurts especially if using leverage. Still, nothing has really changed and the fundamental reasons for long USDJPY are still there, and brave traders will buy the dips for a re-test of Y146.
Consider it’s the actual pace of the sell-off in the JPY that is key, and perhaps the BoJ has done enough to stop an impulsive one-way move for now – if not, and the rate of change is the key factor to use for any JPY trader, then the BoJ will again indicate they are “getting quotes” for the JPY. That’s where I would expect CFD traders to lump into some big JPY longs as an intervention play.

Risky assets need to rally this week if not the market will take their pound of flesh as they go after a response – many are calling for a short-term oversold rally but for me there are still too many questions, and the bulk of the findings point to further USD strength and equity weakness. When we see such incredible moves in bond markets – and poor liquidity is a key factor - you will see big gyrations in FX, commodities, and equity. So, we either hear soothing words from central bankers this week or data needs to come in hotter and maybe an oversold market can attract short covering – but this is a market that is buying put protections like we’ve not seen for years, the USD is king and central bank balance sheets are contracting.

Have an open mind, be a slave to price action and keep your friends close but your stops closer!