Markets Switch to ‘Risk off’, GBP Down on Brexit

The dollar gained against most of its major peers yesterday, with the safe havens JPY and CHF resisting its strength as market sentiment switched to ‘risk off’. The euro gave back a large portion of its latest gains, perhaps as investors remained concerned over Italy’s budget. The pound tumbled on fears that PM May could face a leadership challenge.

Market Sentiment Turns Negative, EUR Reverses Latest Gains

The dollar outperformed all but three of the other G10 currencies on Monday. It gained the most against GBP, NZD, and AUD, while it traded virtually unchanged against JPY, CHF and CAD.

The weakening of the commodity-linked AUD and NZD and the fact that the safe havens JPY and CHF resist the greenback’s strength suggest a switch back to risk off. Indeed, major EU and US indices were a sea of red yesterday, with the only exception being Nasdaq, which closed 0.26% up. The negative sentiment rolled over into the Asian session, with Japan’s Nikkei 225 and China’s Shanghai Composite Index falling 2.70% and 2.26% respectively. Most stock indices closed in the green on Friday, with the positive sentiment rolling into Asian Trading Monday. The catalysts may have been Chinese authorities pledge to support markets as well as easing concerns around the Italian budget, but the cheer did not last for long.

On Friday, Moody’s credit rating agency downgraded Italy’s debt to Baa3 from Baa2, a notch above junk status, but kept the outlook stable. The euro and Italian assets surged, suggesting that market participants were concerned that the agency would also set the outlook to negative. However, the moves were reversed early on Monday, with Italy’s 10-year yields rebounding from their lows and the euro coming under selling interest. Italy’s FTSE MIB ended its session in the red, alongside all other major EU indices.

In our view, yesterday’s market reaction reveals that investors are far from convinced that the clouds over the matter have faded away, and we agree with them. Replying to last week’s warning letter by the EU Commission, Economy Minister Giovanni Tria said that the government would stick to its 2019 budget target of 2.4% but promised not to inflate its deficit in the years ahead. Today, the EU Commission is expected to reject Italy’s budget plan, but according to sources, it may ask the nation for a resubmission. Even though the recent conciliatory tones suggest productive talks in the weeks after today’s possible rejection, the lack thereof could inflate tensions again and keep any possible gains in the euro, as well as Italian assets, limited.

EUR/JPY — Technical Outlook

After a strong spur to the upside during Monday’s European morning, EUR/JPY reversed drastically to the south. Of course, during this intense period that we are experiencing right now with the decline in equities and geopolitical tensions, the yen becomes more and more attractive, where it continues to maintain its safe-haven status. We can see that the price structure on the pair remains lower highs and lower lows, but until it starts breaking the previous low at 128.30, we will remain cautious and take a flat stance for now.

As mentioned above, a break below the 128.30 level, marked by the low of the 18thof October, could invite more bears to the table. This way the pair could confirm an upcoming lower low and thus, we could start aiming for a test of the next potential area of support at 127.85, which held the rate from dropping lower on the 10thof September. If the bears don’t stop there, this could easily drag EUR/JPY towards the 127.35 zone, marked by the low of the 22ndof August.

Our oscillators are difficult to read at the moment, so we will not put too much emphasis on them. The RSI, after briefly moving above 50 yesterday, has now shifted below that mark and seems to be slightly pointing to the downside. The MACD continues to stay flat near the zero line and is fractionally below the trigger line.

On the upside, for us to get comfortable with the idea of EUR/JPY moving higher, we would need to see a good move all the way back above 130.20, marked by the yesterday’s high. This way, the pair could break the continued sequence of lower highs and more bulls could join in the party, which could lead to a test of the 130.50 barrier. A break of that barrier could mean that the bulls are starting to feel comfortable again and a further acceleration of the rate could set the stage for a test of the 131.25 hurdle, marked by the high of the 8thof October.

Sterling Tumbles on Fears of a Leadership Challenge to PM May

The pound fell against all but one of the other G10 currencies yesterday. It lost the most ground against the safe havens JPY and CHF, while it traded virtually unchanged against NZD.

Despite Friday’s rally on reports that UK PM Theresa May is ready to drop a key demand on the Irish border in order to get closer to a deal with the EU, the pound tumbled on Monday on fears that she could face a leadership challenge.

Last week’s reports that the UK government is open to a one-year extension of the Brexit transition period, combined with chatter that it could accept an open-ended backstop plan on the Irish border, triggered frustration among hard-line Brexiteers within the Conservative party. According to the Sunday Telegraph, 46 Tory lawmakers have submitted letters demanding a leadership contest. That’s just shy of the 48 members needed before a challenge can be triggered.

Although reports ahead of May’s speech to parliament suggested that she will dismiss EU’s proposal on the Irish border as unacceptable, which she did, headlines that Northern Ireland’s DUP will back an amendment proposed by hard-liners in order to make EU’s backstop illegal added further pressure to the pound. The currency eventually stabilized somewhat after the UK Times political editor said that a Conservative rebel is set to withdraw amendments that would harden Brexit talks.

As for our view, we believe that the risks surrounding the pound’s near-term direction are tilted to the downside. Uncertainty over the UK’s departure from the EU remains elevated, with Theresa May caught between a rock and a hard place. It appears that the closer she gets in finding common ground with the EU, the harder it becomes for any accord to be approved back home.

GBP/USD — Technical Outlook

Yesterday, GBP/USD broke through its short-term upside support line, taken from the low of the 15thof August. It also confirmed a new lower low, which could invite more bears in order to drive the pair lower again in the near-term. Hence, we would consider the near-term outlook to be negative for now.

As we can see, after the slide, GBP/USD found support near the 1.2955 zone and it continues to balance slightly above it this morning. A break below that zone could confirm a further possible slide towards the next potential area of support at 1.2920, marked by the low of the 4thof October. If that area is not able to withstand the pressure from the bears, then a break of it could open the way to the 1.2870 hurdle, which was the inside swing high of the 4thof September. Also, let’s not forget a possibility for GBP/USD to retrace back up a bit, so that the bears could take advantage of the higher rate and lead the pair back down again towards the above-mentioned levels.

The RSI is already sitting low near 30 and currently remains somewhat flat. The MACD is way below zero and is also below its trigger line but shows signs that it is losing downside speed. Even though both indicators show negative momentum, still, it could be the case that they have already bottomed. This is why we won’t rely on them too much.

Alternatively, a move back above the aforementioned upside support line and a break of the 1.3050 level, marked by yesterday’s intraday swing low, could bring the bull-interest back into the game. GBP/USD could then travel towards the 1.3090 obstacle, a break of which could lead the way towards the 1.3150 barrier, marked by the intraday swing high of the 17thof October.

As for Today’s Events

The calendar appears relatively light on Tuesday. We get the UK CBI industrial Trends orders for October and the Eurozone’s preliminary consumer confidence index for the same month. The UK industrial orders index is expected to have remained unchanged at -1, while Eurozone’s confidence index is forecast to have declined further into the negative territory. Specifically, it is anticipated to have ticked down to -3.0 from 2.9.

With regards to the energy market, we get the American Petroleum Institute (API) crude inventory report, but as usual, no forecast is available.

As for the speakers, we have five on the agenda: BoE Governor Mark Carney, BoE Chief Economist Andy Haldane, Minneapolis Fed President Neel Kashkari, Atlanta Fed President Raphael Bostic, and Chicago Fed President Charles Evans, who speaks during the Asian morning Wednesday.

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