FX Technical Analysis

This page aims to provide the major technical indicators used in Finance, and especially in the Foreign Exchange market. In addition to define the several steps to compute each specific indicator, I describe a potential systematic (and tactical) strategy applied to currencies and also provide an Excel File (with VBA macros). Hence, readers are able to see how those technical indicators are built, and then can backtest a few strategies on exchange rates using their own parameters.

I chose to first start with the major indicators I learned straight after I joined my first FX trading team in London. There are the Moving Average (Simple and Exponential), the Relative Strength Index (RSI), the Moving Average Convergence Divergence (MACD) and the Bollinger Bands.

  1. Link to Momentum Indicators ===> TA_Momentum
  2. Link to Reversal Indicators ===> TA_Reversals
  3. Link to Excel File ===> TechnicalAnalysis_Indicators

Figure 1. Performance of a L/S Portfolio using EMA(5,20) on USD/AUD

Performance.PNG

Global Macro: trade on China’s weak signs and Draghi’s Will to Power

This article deals with a few current hot topics:

  • The main one gives an update on weakening signs of giant China
  • The second one reviews the ECB Thursday’s meeting, presented with a couple of FX positioning
  • The last one is on the debt ceiling debate and risk-off sentiment

China desperately flowing…

As I am looking at the current news in the market, there has been a lot of interesting topics to study over the past couple of months. I will first start this article with an update on China and its weakening economy. Since the Chinese ‘devaluation’ on August 11th, I have been focusing much more in the EM and Asian Market as I strongly believe that the developed world is not yet ready for a China & Co. slowdown. I heard an interesting analysis lately, which was sort of describing the assets that had performed since the PBoC action more than two months ago. As you can see it on the chart below, Gold prices (XAU spot) accelerated from 1,100 to a high of 1,185 reached on October 14th, and Bitcoin recovered from its low of 200 reached in late August and now trades at $285 a piece.

ChinaandBitcoinGold

(Source: Bloomberg)

One additional explanation that I have for Gold is that I believe that the 1,100 level could be an interesting floor for long-term investors interested in the currency of the last resort. The weak macro, loose monetary policy, low interest rates and more and more currency crisis in EM countries will tend to bring back gravity in Gold, especially if prices become interesting (below $1,100 per ounce) for long-term buyers.

Looking at the CSI 300 Index, we still stand quite far from the [lower] historical high of 5,380 reached in the beginning of June last year. Since then, as a response, we had a Chinese devaluation, the PBoC cutting the minimum home down payment for buyers in cities last month (September 30th) from 30% to 25% due to weak property investment, and then a few days ago the PBoC cutting the Reserve Requirement Ratio (RRR) for all banks by 50bps to 17.50% and its benchmark lending rate by 25bps to 4.35%. Looking at all these actions concerns me on the health of the Chinese economy; it looks very artificial and speculative. In a late article, Steve Keen, a professor in economics explained that the Chinese private-debt-to-GDP ratio surged from 100% during the Great financial crisis to over 180% in the beginning of 2015, amassing the largest buildup of bad debt in history. Its addiction to over expand rapidly have left more than one in five homes vacant in China’s urban areas according to the Survey and Research for China Household Finance. Banks are well too exposed to equities and the housing market, and it looks that they have now started a similar decline as the US before 2008 and Japan before 1991. To give you an idea, the real estate was estimated to be at 6% of US GDP at the peak in 2005, whereas it represents roughly 20% of China’s GDP today.

ChinaPrivatedebt

(Source: Forbes article, Why China Had to Crash)

I wrote an article back last September where I mentioned that the Chinese economy will tend to slow down more quickly than analyst expect, therefore impacting the overall economy. We saw that GDP slide to 6.9% QoQ in the third quarter, its slowest pace since 2009 and quite far from the 7.5%-8% projection in the beginning of this year.

Draghi’s Will To Power

One fascinating event this week was the ECB meeting on Thursday. Despite a status quo on its interest rate policy, leaving deposit rate at -0.2% and the MRO at 5bps, a few words from the ECB president drove immediately the market’s attention. He said exactly that ‘The degree of monetary policy accommodation will need to be re-examined at our December policy meeting’, therefore implying that the current 1.1 trillion-euro program will be increased. As you can see it on the chart, EURUSD reacted quite sharply, declining from 1.1330 to a low of 1.0990 on Friday’s trading session, and sending equities – Euro Stoxx 50 Index – to a two-month high above 3,400. Italy 2-year yield was negative that day (hard to believe that it was trading above 7.5% in the end of November 2011).

ECBmeeting

(Source: Bloomberg)

 I am always curious and excited to see how a particular currency will fluctuate in this kind of important events (central banking meeting usually). One thing that I learned so far is to never be exposed against a central bank’s desire; you have two options, either stay out of it or be part of the trend.  I think EURUSD could continue to push to lower levels in the coming days, with the market slowly ‘swallowing’ Draghi’s comment. I think that the 1.0880 level as a first target is an interesting level with an entry level slightly below 1.1100 (stop above 1.1160).

USDJPY broke out of its two-month 119 – 121 in the middle of October down to almost 118, where it was considered as a buy-on-dip opportunity. It then levitated by 3 figures to 121.50 in the past couple of weeks spurred by a loose PBoC and ECB. The upside looks quite capped in the medium term if we don’t hear any news coming from the BoJ. The upside move on USDJPY looks almost over, 121.75 – 122 could be the key resistance level there.

USDJPYTrade

(Source: Bloomberg)

Potential volatility and risk-off sentiment coming from the debt ceiling debate

On overall, with US equities – SP500 index – quietly approaching its 2,100 key psychological resistance with a VIX slowly decreasing towards its 12.50 – 13 bargain level, I will keep an eye on the debt ceiling current debate in the US, which could trigger some risk-off sentiment in the next couple of weeks (i.e cap equities and USDJPY on the upside). Briefly, the Congress has to agree on raising the debt limit to a new high of 19.6tr USD proposed (from 18.1tr USD where it currently stands). The debt limit is the total amount of money that the United States government is authorized to borrow to meet its existing obligations, and the current debt ceiling proposal’s deadline is November 3rd. No agreement would mean that the US government could default on its debt obligations, which could potentially increase the volatility in the market.

The chart below shows the increase of the debt ceiling since the early 1970s, after the Nixon Shock announcement which led to the end of Bretton Woods and the exponential expansion of credit.

USceiling

(Source: The Burning Platform) 

Japan and the Yen, where do we stand now?

On October 31st, Governor Kuroda announced that the BoJ will raise (by a 5-4 majority vote) its bond-buying program. We saw the reaction since then; USDJPY soared from 112+ then to 120 (with a high of 121.86 on December 7). Some analysts think that the move was/is exaggerated, but if you put the figures on table, it looks reasonable to me. By announcing that the Bank of Japan will buy between 8 and 12 trillion JPY of JGBs each month, it means that it will purchase the total 10tr Yen of new bonds issued by the Ministry of Finance; in other words, full monetization. As a reminder, the central bank is the largest single holder of JGBs (with 20%+ of the shares), and could end up owing half of the JP bond market within the next 3 to 4 years.

With the country now in a triple-dip recession (GDP contracted by 1.9% in the third quarter) and the inflation rate slowing down for the fourth consecutive month in November (core CPI, which excludes volatile fresh food but include oil products, rose 2.7% in November, down from 2.9% in September and 3% in October), I see just more ‘power’ coming from Japanese policymakers. Elected in December 2012 as Japan PM (the seventh one in the last decade), I am convinced that Abe (and Kuroda/Aso) cannot fail this time and will (and must) continue to go ‘all-in- on his plan. That will mean aggressive easing, therefore constant depreciation of the currency JPY in the MT/LT. Remember the graph I like to watch: Central Bank’s total assets as a percent of the country’s GDP (see article It is all about CBs).

In fact, as many analysts have stated, the hit from the sales tax increase back in April turned out to be bigger than expected. The second one, which was set for October 2015 and would have seen a 2-percent rise to 10 percent, has already been postponed for early 2017 according to Abe’s announcement last month. When will the country work on its budget balance? As a reminder, Japan has been showing a 8%+ budget deficit over the past six years, which rose the level of its debt to a ‘unsustainable’ 230% as a share of GDP.

Another major problem that the third-largest economy will have to deal with in the long term is its population. The chart below (Source: the Economist) shows the evolution of Japan’s population from 1950 to 2055 (forecast). It is aging, and that is terrible news for all the pension or mutual funds as many people from the Japanese workforce will switch from being net savers to net spenders.

20141213_gdc700(Source: the Economist)

With a population of 127 million in 2013, the number of people is expected to fall below 100 million by the middle of this century due to the low birth of rate (total fertility rate of 1.4 in 2013).

In my article last month on the Japanese Yen History, I added a quick ‘technical’ chart and stated that we may see some take profit a 120 and that the pair should stabilize at around that level based on the downtrend line. And each time I have some discussion about the Yen, I always say there are two ways to play it:
– either keep it short (against USD or GBP) for those who are looking for a medium or long term view;
– or buy the pair (USDJPY) on dips if you try to catch nice trends. Don’t try to short it, unless you are really confident and have been doing it for a while. All traders I know are looking for buying opportunities on the pair.

Speaking of that, it looks to me that the core portfolio I have been carrying over the past few months now – Short EUR (1/2) , JPY (1/2) vs. long USD (2/3) and GBP (1/3) – has been quite profitable, and I still believe there is more room. At least, it makes sense on the idea I had about ‘monetary policy divergence’, with the US and UK considering raising rates (no printing/QE) while EZ and Japan aggressively printing with NIRP/ZIRP monetary policies. I will try to write a piece shortly on the Euro while I am working on my 2015 outlook.

Update on Kiwi, RNNZ on hold as expected…

The Kiwi has remained under pressure against the greenback since the middle of July when it flirted with its 3-year resistance at 0.8840. Since then, we saw a lower than expected CPI that printed at 1.6% in Q2 on July 15 (vs 1.8% expected) followed by a dovish stance from RBNZ policymakers on July 24th. Despite the central bank raised its OCR by 25bps for the fourth time this year to 3.5% (in line with investors’ expectations), Governor Wheeler indicated that the central bank was considering a pause in the following meeting after the 1% shift.

Therefore, investors lost interest in the currency (probably some take profits above 0.8800) and the negative trend started. I have remained bearish on the currency since the central bank’s last statement, and I anticipated the NZD to depreciate even more against the USD ahead of the RBNZ meeting (September 10th). As expected, the central bank left rates unchanged yesterday and added that ‘softer inflation might limit the extent of rate hikes’, pushing NZD/USD below the 0.8200 level (trading at 0.8175 as you can see on the chart below).

I set my target at 0.8050, which corresponds to February 2nd (2014) low.

KiwiDol(1)

(Source: Reuters)

Buy the dips on NZD/JPY?

It looks to me that the 14-day SMA (orange line) has been acting as a ‘strong’ support on NZD/JPY for the past couple of weeks. Despite my bearish sentiment on the Kiwi, I also turned bearish on the Yen and I believe that bearish Yen is preferable to bearish Kiwi. Therefore, I will try to buy some at around 87.30, stop loss below 86.90 with a target at 88.00.

NZD-11-Sep(1)

(Source: Reuters)

Fighting against the Aussie…

An interesting development overnight was the Australian Q2 inflation data which is approaching the higher band of the 2-3% RBA target range. Australia’s trimmed mean CPI, the indicator the RBA officials look at which excludes volatile items that are included in CPI, rose from 2.6% to 2.9% in the second quarter (expected at 2.7%). The news lifted the Aussie to 0.9450 against the greenback as it slowed down the market’s expectations of another rate cut further this year.

AUDUSD started to recover from its last-week ‘losses’ after RBA Governor Stevens didn’t mention anything about the exchange rate overvaluation at a charity lunch in Sydney on Tuesday. As you can see it on the chart below, the increase in the 2-year AU-US yield spread (in blue) has pushed AUDUSD (yellow bars) to higher levels and the pair is now flirting with its resistance at 0.9460. A breach of that level could easily bring us to the next resistance area 0.9475 – 0.9500 (which corresponds to levels we saw in the beginning of the month).
I remain bearish on the Aussie and I think that a bounce back above 0.9500 could be another interesting level to start shorting the pair with a stop loss above 0.9560. My medium term target remains at 0.9200.

AUD-Spread

(Source: Reuters)

Another graph that I like to watch is AUDJPY. As you can see, the pair is approaching its first strong resistance at 96.00 (currently trading at 95.90). It seems that the market has been rejecting AUDJPY above this level over the pas few months, and for those who are not convinced on the AUDUSD trade, it could be also interesting to enter a short position on AUDJPY at current levels, with a stop loss above 96.60 and a first target at 94.60.

AUDJPY-23Juy

(Source: Reuters)

Markets after Yellen…

There have been some interesting developments for the past few days in the middle of this low-volatile environment. Firstly, Fed Chair Yellen opened two days of testimony on Capitol Hill yesterday, delivering the central bank’s semi-annual report to Congress. With the QE-Taper to end in October (already priced in), the market was waiting for more details concerning the ‘future path’ of the Fed Funds target rate (currently at a historical low of 0-0.25%). Despite strong employment data with Non-Farm Payrolls printing above the 200K level for the fifth month in a row in June (288K) and the jobless rate that edged down by another 0.2% to 6.1% (2008 levels), Yellen clearly stated that the US economic recovery ‘is not yet complete’ with the housing market showing ‘little progress’ but still disappointing this year.

However, she surprised the market a bit when she told the Senate Banking Committee that rates could rise sooner than planned. These comments ‘kind-of’ played in favour of the US Dollar, with USD index trading 80.50 at the moment. Its main component, the Euro (57.6%), broke out of his tight 1.3575 – 1.3675 range and is now trading at 1.3540 (see chart below). The next support on the downside stands at 1.3520, the 38.2% Fibonacci retracement of 1.2750 (July 2013 low) and 1.3992 (May 2014 high).

EUR-16-Jul

(Source: Reuters)

The second interesting development was the higher-than-expected CPI figures in UK that gave a boost to Cable after its last two weeks of weakening momentum. Annual inflation came in at 1.9% YoY in June (vs expectations of a 1.6% print), while CPI MoM increased by 0.2% (vs -0.1% consensus). It reinforced the market’s view that the BoE will be the first major central bank to lift rates. Even though some analysts are expecting a first move from UK policymakers later this year, I personally think that Q1 2015 sounds more reasonable. If we have a look at short-sterling interest rate futures, the March 2015 contracts sold off to 98.91 from 98.97, which means that the implied yield from 103bp to 109bp. Earlier this morning, UK claimant counts fell by 36.3K in June, following a revised 32.8K drop registered in May. The jobless rate edged down to 6.5% as expected.

After it reached a high of 1.7191 yesterday afternoon, Cable remains poised for a break above 1.7200 and is now trading at 1.7125. The first support on the downside stands at 1.7100, followed by 1.7060. A more interesting pair would be EUR/GBP, which is now trading at a 22-month low at 0.7900 and is approaching its next support at 0.7880 (see chart below).

EURGBP-16-Jul

(Source: Reuters)

Another surprise came from New Zealand where inflation accelerated less than expected, easing pressure on the RBNZ to continue its monetary policy tightening cycle. As a reminder, the central bank has increased its overnight cash rate (OCR) three times to 3.25% since the beginning of the year, and the market is still expecting a 25bps rate hike at the next meeting on July 23rd. I felt that the Kiwi strength would probably weigh on NZ policymakers’ decision at the next meeting, therefore I was expecting a correction on NZD (see my last trade short NZD/JPY). It was also interesting to play a technical bear correction on NZD/USD when the pair was flirting with its 3-year high as you can see it on the chart below.

NZD-16Jul

(Source: Reuters)

Quick update on BoJ and the Yen: USDJPY continues to trade sideways after the BoJ decided to keep its monetary policy unchanged (as expected), maintaining its target of increasing the monetary base at a annual pace of JPY60-70tr per year. The central bank cut its 2014 growth prediction to 1.0% (down from 1.1% last meeting and from 1.5% last October), but the board (9 members) unanimously maintained its inflation projection of 1.9% in the next fiscal year. If we have a quick look at the chart below, USDJPY is still trading within its tight 101.00 – 103.00 range. It found support slightly above the 101.00 level last week and seems on its way to test its next resistance at 101.94 (200-day SMA).

JPY-16-Jul

(Source: Reuters)

To finish, another currency AUDUSD that I have been trying to play lately is AUDUSD. The RBA minutes didn’t surprise the market on Tuesday despite AU policymakers’ willingness to see a lower Aussie (the minutes stated ‘the exchange rate remained high by historical standards’). I still think it is interesting to go short AUDUSD if the pair trades above 0.9400, with a medium term target at 0.9200 and a stop loss above 0.9560.

AUD-16Jul

(Souce: Reuters)

Quick Overall update…

This week has started with limited risk appetite as situations in Iraq and Ukraine both remain intense. US yields still struggle to take off in the middle of this QE Taper environment (10-year is trading below the 2.60% level), while Gold and Silver both continue to soar and are now trading above 1,300 and 21.00 levels respectively. The US Dollar remains offered against most of the G10 / EM currencies; as you can see it on the chart below, the USD index continues its bearish momentum and is now trading at 80.23 between its lower Bollinger Bands (20, 2.0) and its 200-day MA.

usdiNDEX

(Source: Reuters)

Dollar Bloc: Low vols sustain demand for Dollar Bloc currencies and especially the Canadian Dollar. Since its high of 1.1278 on March, USDCAD has entered into a bearish momentum as the Loonie continues to benefit from higher than expected CPI figures. As a reminder, annual inflation came in at 2.3% in May (vs 2.0% consensus) and stands now above the BoC 2-percent target. USDCAD broke its 200-day (1.0783) last week and visited its 5-month low at 1.0710 earlier this morning. The next support on the downside stands at the psychological 1.0700, followed by 1.0650 (Jan 7).

Yen: Low US yields in addition to a quite Japanese overnight session add pressure on USDJPY, still trading below 102.00. The pair has been stuck within a 70-pip range for the past couple of weeks, trading above its 200-day MA (101.65) and below its 100-day MA (102.20). The pair’s vols stands at their lowest level; the 1-month ATM volatility decreased to 5.02% (from 10.2% in the beginning of February). USDJPY looks vulnerable and I would carefully watch the downside at the moment; a break of the 200 MA would push the pair back to its strong support at 100.75. On Friday, we will get an update on inflation and household spending figures in Japan; Core Nationwide CPI is expected to increase to 3.4% in May (up from 3.2% the previous month) and could continue to disappoint investors on the easing measures (no signs of urgency from BoJ policymakers).

Euro: I expect the single currency to come back under pressure in the medium term as it seems that the ECB is not done with easing. Final Inflation came in at 0.5% YoY in May a couple f weeks ago and flash EZ Mfg. PMI printed below expectations of 53.5 at 52.8 (French Mfg. PMI was miserable at 47.8). Traders will watch closely updates on Inflation (flash) and ECB figures (Private loans and Money Supply) next week on Monday. EURUSD is trading back above 1.3600; the next resistance zone is seen between 1.3660 (higher Bollinger Band) and 1.3670 (200-day SMA).

Sterling: After Carney’s hawkish comments at the Mansion House that the BoE will consider raising its Official Bank Rate (currently at a historical low of 0.5%) sooner that the market expects (which meant Q1 instead of Q2 previously), today’s testimony before the Treasury Select Committee sounded a bit dovish. BoE Governor said that the ‘exact timing’ if a rate increase will be ‘driven by the data’ and will be ‘limited and gradual’ based on the central bank’s estimation. The 2-year UK-US yield spread shifted lower to 41.1bps this morning (down 4bps), bringing Cable below the 1.7000 level. There has been a large build of long Sterling positions for the past few weeks based on monetary policy divergence (long GBPCHF, GBPJPY or short EURGBP are popular positions to hold at the moment), and the dovish stance of this morning may be another good opportunity to enter (buy on dips / sell on rally) for traders or investors.