EURUSD Recovery Falters after US Inflation Reading, Friday Sentiment Data Can Extend

QQQ Nasdaq 100 ETF, VIX, Inflation, Dollar, EURUSD and USDJPY Talking Points

• The Trade Perspective: Pairing Dow Bullish to Nasdaq 100 Bearish; EURGBP Bearish Below 0.8425; AUDCAD Bearish Below 0.9325
• Wednesday’s charge in hope for a risk asset recovery collapsed this past session but volatility remains every present
• Inflation and monetary policy is pulling attention away from Ukraine once again with EURUSD and USDJPY both facing major technical levels

The Risk Recovery Effort Loses Traction Yet Again

While there wasn’t a lot of fundamental support for the exceptional rally in risk assets through Wednesday’s session, the intensity of the move for the likes of the S&P 500, the DAX 40 and junk bonds was extraordinary enough to leave reasoning for later. Yet, conviction matters when your trying to stage lasting reversals or simply developing a genuine trend in either direction. This past session, the speculative charge collapsed across the board. Using the tech-heavy Nasdaq 100 ETF (QQQ) for reference, a gap lower on the open accounted for the totality of the -1.1 percent drop through the day. Other US indices, global stock markets and alternative ‘risk’ assets put in for differing intensities but were largely lower – correlation across otherwise loosely related markets is my preferred measure of sentiment. Overall, this week’s trading suits a ‘wedge’ formation which reflects pressure build up. We may very well extend this period of consolidation through Friday and into the weekend as next week’s docket carries serious anticipation (including Wednesday’s FOMC rate decision). Yet, I won’t be relying on assumptions in these market conditions. I’ll remain tuned in.

Chart of QQQ Nasdaq 100 ETF with 20 and 200-Day Mov Avgs, Gaps, 20-Day ATR (Daily)

Chart Created on Tradingview Platform

A major reason to remain tuned into the markets is the state of volatility. While I believe ‘realized’ activity measures are more worrying than the ‘implied’ figures that have seen their hedging values diminished over the past decade, even the likes of the VIX offers reason to be cautious. The S&P 500-derived volatility index closed at its lowest level since February 28th this past session, but the general trend is still pushing higher. That is also true of the ‘volatility of volatility’ index (VVIX) where the 20-week average is pushing towards levels that reflect a state where sudden bouts of instability arise with little warning. If you are watching volatility data, the US stock market is not the only area of the financial system worthy of your attention. Two other specific assets that have proven themselves prone to the fundamental upheaval over the past two weeks are Treasuries (bonds) and oil (commodities). There are activity gauges from both, and each is pulling back from levels comparable to the height of the pandemic. If there are any Ukraine-oriented flare ups, these are three important barometers.

Chart of the VIX Equities, MOVE Bond and OVX Oil Volatility Indices (Daily)

Chart Created on Tradingview Platform

Inflation and Monetary Policy are Gaining More of the Attention from Headlines

While breaking headline can generate greater volatility in the market – as they more often come ‘out of the blue’ – it doesn’t make for very practical trading preparation. That has made first two weeks of Russia’s invasion of Ukraine difficult for global market participants. Yet, the updates from that part of the world reporting that high level meetings between delegates from each country have once again yielded no meaningful ceasefire doesn’t seem to surprise investors much anymore. Instead, the attention seems to be turning toward the economic and financial impact that is spreading across the world. The IMF’s Director warned this past session that their global growth forecast was likely to be downgraded owing to the war, but most already knew that was coming given the pain from inflation. The sharp rise in energy, metal and ‘softs’ commodities has effectively clued the world into the hardships ahead. It was that awareness that nudged the ECB to further lay out its timetable for normalizing its policy (end stimulus by Q3 and then contemplate rate hikes) and push the forecasts for US inflation well above the current CPI reading.

Calendar of Major Economic Events

Calendar Created by John Kicklighter

Inflation is a problem. Left unchecked, high inflation can snuff out economic growth, turn real rates of return deeply negative and create problems in the flows of capital throughout the financial system. Then again, after years of exceptionally accommodative policies from the Fed and others, there is an unmistakable dependency that has been built around this perpetual safety net – virtually necessitating taking on greater risk in order to beat ‘the market’ (the S&P 500). That makes pulling back on the abundant liquidity a potentially dangerous proposition – but it is necessary. This past session, the US headline CPI reading met expectations of a 40-year high 7.9 percent clip. That will make Friday’s top event risk, the University of Michigan consumer confidence survey, even more interesting. How concerned are Americans over inflation? Their spending accounts for roughly three-quarters of GDP in the world’s largest economy. That is a matter for far more than just the US markets.

US CPI Year-Over-Year Overlaid with UMich Consumer Confidence Inverted (Daily)

Chart Created on trends.google.com

The Top Markets (Pairs) to Watch for Friday

Though our attention has been trained on general risk trends through the first half of this past week, the pull of relative monetary policy as an endpoint to growth forecasts and relative inflation fights is an undercurrent I suspect that we will keep coming back to. Regardless of which theme is winning the day, it seems to favor the US Dollar. Should we see a decisive risk aversion, we are in a state where such a slump puts us on the cusp of a more dramatic flight to safety. That is a role the Greenback plays well. In the more nuanced world of rate forecasting, we find Fed rate forecasts have jumped back up to 155 basis points priced in through the end of this year. Notably however, after the stronger CPI reading, the modest speculation of a 50 bp hike come Wednesday evaporated. Perhaps crude oil prices are carrying more of the market’s expectations. Regardless, the ECB’s waffling this past session still offers one of the more substantial disparities in rate forecasts while also maintaining a definitive contrast in ‘risk’ stance. EURUSD put in for a very notable hold and reversal from former support at 1.1125 this past session, but I chalk that up more to market conditions than the technicals themselves. I do love when those different elements converge however.

Chart of EURUSD with 100-Day SMA and 1-Day Rate of Change (Daily)

Chart Created on Tradingview Platform

Another pair with some of the same fundamental connections with EURUSD while also carrying some crucial differences is USJDPY. In terms of the relative policy contrast, this may be the most extreme counterpart we can find in the majors. That said, the risk perspective is muddled as the Dollar is a preferred haven really only at the extremes. To further complicate the situation, there is the added issue of commodity inflation. As the cost of raw materials rise, Japan is far more dependent on exports of these resources and thereby has to purchase foreign currency that is the principal fiat used to deal in these goods (typically Dollars). That said, as oil prices pullback, the critical range high around 116.50/25 feels less pressure for a break. Alternatively, a hawkish Fed view puts lift back into the market. This is no small overhead as the range high is more importantly an overlap with a multi-decade wedge resistance. Just remember, a break does not guarantee follow through.

Chart of USDJPY with 100-Day SMA, 20-Day ATR and Historical Range (Daily)

Chart Created on Tradingview Platform