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by Charalambos Pissouros

Markets Trade “Risk Off” on US-China Tensions, GBP the Main G10 Loser

The financial world turned to risk-off yesterday, following fresh tensions between the US and China ahead of the high-level negotiation that begin in Washington tomorrow. Among the G10 currencies, the pound was the main loser, coming under fresh selling interest after German Chancellor Angela Merkel told UK Prime Minister Boris Johnson that a Brexit deal is “overwhelmingly unlikely” if Northern Ireland is not left in the EU’s customs union.

US-China Truce Hopes Fade, Pound Slides as Brexit Deal Seems Unlikely

The dollar traded higher or unchanged against most of the other G10 currencies on Tuesday and during the Asian morning Wednesday. It gained against GBP, NOK, SEK and CAD in that order, while it was found nearly unchanged versus EUR, AUD and NZD. The greenback lost some ground only against CHF and JPY.

USD performance G10 currencies

The fact that the safe havens yen and franc were yesterday’s main gainers suggests that investors’ appetite took a 180-degree turn yesterday. Indeed, major EU and US indices closed their sessions in the red, with the negative sentiment rolling somewhat into the Asian trading today. Strangely, China’s Shanghai Composite closed 0.39% up, but Japan’s Nikkei 225 slid 0.61%.

Major global stock indices performance

Once again, the driver behind the deterioration in market sentiment was headlines surrounding the US-China trade sequel.  It all started after China’s Commerce Ministry said that they would retaliate on the US’s decision to blacklist 28 Chinese companies, while the US government widened its list to include some artificial intelligence start-ups. Later in the day, things got even worse as the US State Department said it has imposed visa restrictions on Chinese government and Communist Party officials over China’s treatment of Muslim minorities in Xinjiang province.

Yesterday morning, we noted that there was a decent chance for the new round of trade talks, scheduled for Thursday and Friday, to result in some sort of a preliminary deal, or at least bring the world’s two largest economies closer to finding common ground. However, yesterday’s developments have weighed on such hopes, and that’s why equities tumbled, and safe havens rallied. Interestingly, the PBoC set the onshore yuan rate nearly unchanged overnight. Someone would have expected them to set it lower after yesterday’s tensions, but again they may be waiting to see whether the talks will eventually result in something good or fall apart.

Back to the currencies, the pound continued drifting south yesterday, and today, it was found as the main loser among the G10s. In a telephone conversation, German Chancellor Angela Merkel told UK Prime Minister Boris Johnson that a Brexit deal is “overwhelmingly unlikely” if Northern Ireland is not left in the EU’s customs union, with a UK government source saying that a deal is essentially impossible as the German Chancellor had made unacceptable demands.

GBP performance G10 currencies

As for our view, with the clock ticking towards the current Brexit deadline, which is on October 31st, and the two sides still far apart, we believe that the path of least resistance for the pound remains to the downside. Boris Johnson remains adamant that he will take the UK out of the EU on October 31st, with or without a deal, which keeps the risk of a disorderly exit at the end of the month well on the table. For the pound to reverse north, a deal should be struck by October 19th, which appears to be an imaginary case at the moment, or the two sides would have to agree on a new extension.

AUD/JPY – Technical Outlook

From around mid-September, AUD/JPY drifted lower, trading below a short-term downside resistance line taken from the high of September 13th. That said, from the first day of October, the pair is struggling to close below the 71.80 support zone. We will keep a close eye on that area and wait for its break, before examining lower areas. For now, we will stay cautiously bearish.

It seems that the gateway to lower levels is at the above-mentioned 71.80 level, a break of which would confirm a forthcoming lower low and the pair may slide to the 71.08 territory, marked near the lows of August 29th and September 3rd. This is where the initial hold-up might occur. The rate may even rebound back up a bit. But as long as it continues to run below the 71.80 zone, we will consider this move higher as a correction, before another leg of selling. Another slide to the 71.08 obstacle and then its break may lead the pair to its next potential support level, at 70.21, marked by the low of August 26th.

Alternatively, if AUD/JPY receives some buying interest, breaks the previously-mentioned downside line and climbs above the 200 EMA on the 4-hour chart, this might be seen as a sign that the pair has a chance to drift further north. But we will get more comfortable with higher areas if we see a break above the 73.36 barrier, marked by the high of October 1st. This way, we could start considering the 73.83 hurdle as our next potential target, a break of which could clear the way to the 74.49 level. That level marks the highest point of September.

AUD/JPY 4-hour chart technical analysis

EUR/GBP – Technical Outlook

Yesterday, after breaking above its key resistance barrier, at 0.8937, EUR/GBP moved sharply to the upside, but got held near the psychological 0.9000 zone. From there, the pair retraced back down a bit, but this move could be seen as a temporary correction before another leg of buying. We can see that at the same time, the pair is trading above its medium-term downside resistance line, drawn from the high of August 12th, and above its short-term upside line, which is taken from the low of September 20th. Given everything what was mentioned above, we will stay somewhat positive, at least over the short run.

If this time, another attempt to break above the 0.9000 barrier is successful, and the pair also clears the 0.9015 zone, which is the high of September 9th, this could open the door for a further move higher, as more buyers could see it as a good opportunity to step in. EUR/GBP may then test the 0.9090 obstacle, a break of which could set the stage for a move to the 0.9150 level, marked by the high of September 3rd.

Alternatively, for us to consider lower areas again, we would have to wait for a move below both of the aforementioned lines, the upside and the downside one. But for a better confirmation, a drop below the 0.8845 hurdle, which acted as a good support zone between September 26th and October 3rd, could do the trick for more sellers. The rate might then slide to the 0.8786 area, marked by the lowest point of September. Initially, EUR/GBP may stall around there, or even correct back up a bit, but if it fails to move back above the 0.8845 barrier, we will aim lower again. A drop below the 0.8786 obstacle would confirm a forthcoming lower low and we could see a move to the 0.8724 level, marked by the low of May 21st.

EUR/GBP 4-hour chart technical analysis

As for Today’s Events

We get the minutes from the September FOMC meeting, when the Committee decided to cut interest rates by 25bps. The new “dot plot” pointed to no more cuts this year and the next, one hike in 2021 and another one in 2022. That said, despite the 2019 median dot suggesting that there are no more rate reductions on the table, the Committee was largely divided, with only 5 members supporting that view. Seven still believed that another quarter-point reduction may be appropriate, while the remaining 5 argued that the last cut was not needed. So, having all these in mind, we don’t expect the minutes to paint a different picture. We just expect them to confirm the disagreement with regards to the future path of interest rates.

What’s more, given that we heard from Fed Chair Powell yesterday, and also that the meeting took place ahead of the disappointment in the ISM indices, we will treat the minutes as outdated. The Fed Chief repeated that the Committee will “act as appropriate” and that policy is never on a pre-set course. They will assess the outlook and risks on a meeting-by-meeting basis, Powell said. This allowed investors to stay well convinced that officials will push again the cut button when they meet next. According to the Fed funds futures, they now see a 86% chance for another quarter-point cut to be delivered at the October 29th-30th gathering.

Fed funds futures market vs FOMC interest rate expectations

As for today’s data, the US JOLTs Job Openings for August are coming out, and the forecast points to a small decline, to 7.191mn from 7.217mn in July. We also get the EIA (Energy Information Administration) weekly report on crude oil inventories, which is expected to show a 1.413mn barrels build, less than the previous 3.100mn. That said, bearing in mind that, yesterday, the API (American Petroleum Institute) revealed a 4.100mn barrels increase, we would consider the risks surrounding the EIA forecast as titled to the upside.

We also have two speakers on the agenda: We will get to hear again from Fed Chair Jerome Powell, while Kansas City Fed President Esther George will also step up to the rostrum.

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