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Tuesday, April 18, 2017

When in doubt about on positive sentiment toward the Trump reflation trade, SELL Dollars.

The dollar index is again approaching the lowest lows from yesterday, despite the 10- year note yield seemingly stabilizing. Both the euro and sterling are on the rise for their own reasons, although an earlier drop in dollar/yen may be ending already. Euro/GBP  also already breaking its support line to the downside. See the chart below:

Uncertainty is high about a number of issues—too many issues. The biggies are geopolitical, with N. Korea and the French election front and center, but we also have conflicting views on the US outlook, with soft data in conflict with rising consumer and business confidence. And poking everyone in the eye is a FT interview yesterday with TreasSec Mnuchin, who tried to square the circle by saying Trump’s preference for a weaker dollar is a short-term view but the true long-term US policy is that “a strong dollar is in the US best interests.”

You have to wonder when G20 and G7 start complaining about the US meddling in the FX market and fomenting currency war. Germany will issue a “G20 chairman’s letter” at the end of meetings this week, being held at the same time as the IMF/World Bank. Reuters reports the letter will stress the importance of globalization and free trade for growth.

And on the domestic political front, the likely delay in tax reform and infrastructure spending is pushing down the equity indices. Futures point to a down day today. In other markets, Bloomberg reports Asian equity trading saw a collapse on miners as iron ore prices are falling over 7% in just two days. “There was better news for oil bulls, however, with Citigroup Inc. predicting a barrel of crude would trade in the mid-$60s by the end of the year.” Oil prices have yet to respond.

• In Australia, a surprise—the AUD took a hit on a gloomy RBA statement from the April policy meeting that the labor market is still weak and house prices still rising too much, calling for “careful monitoring.” Never mind that better jobs data came out after the policy meeting. 

• In the UK, another surprise—PM May announced a snap election on June 8 to strengthen her negotiating position with the EU on Brexit terms. She is expected to gain a far wider majority that will silence critics. Sterling spiked from 1.2608 to 1.2513 but recovered right away to 1.2597 and 1.2659 at 6:55 am ET, or over 140 points in a single hour.

• Trump will sign an executive order today strengthening existing “Buy American” and “Hire American” mandates. One of these is specifying public project must contain US-made steel; made abroad and finished in the US will no longer qualify. Trump built many buildings, including the Washington hotel, using foreign steel.

• The Treasury report on capital flows yesterday shows both Japan and China increased holdings of Treasuries, Japan by $12.6 billion and China by $8.6 billion. It’s the first increase by both countries since Feb 2016. The FT reports “Overall, offshore investors increased their holdings of long-term US assets by $53.4bn in February, up from $5.9bn of purchases a month prior. Investors have scrutinized the reports over the past year, as Beijing tried to manage capital flight, selling Treasuries to defend the renminbi. It had been a point of consternation for holders of the paper, which have slid in value since the US election. While the yield on the 10-year Treasury has fallen to its lowest level since November, it remains 40 basis points above where it traded hands on election day.”

Euro/Usd Outlook: 

The euro is off the lowest lows as traders decline to be scared of the French election next Sunday. It has hand-drawn red support around 1.0601. This may mean FX traders believe Macron will win or that LePen will lose, although the bond boys seem not to agree—the French-German 10-year spread remains about 70 bp.

The FT notes increasing popularity of European equity funds over US funds that are fully priced or maybe overpriced. SocGen’s Juckes says “The medium-term case for the euro to usurp the dollar as strongest of the major currencies grows steadily even if European political uncertainty holds it back in the short term.’’ Juckes is always to be heeded.

The U.S 10-year yield index closed at 2.252% from 2.232% last Thursday but is softer at 2.223% this morning. Yesterday’s bar is an engulfing bull candlestick (lower open, higher close), which promises a higher high today.

The Bund yield is also softer at 0.178% from 0.191% yesterday morning.

Market Outlook:

Markets are not very good at pricing geopolitical risk. On Friday it seemed as though the yen should keep rising on the conflict between the US and North Korea (and never mind that Japan itself is involved), but otherwise, the dollar should be strong on the hawkish Fed. The euro should fall as worries multiply about the French election this Sunday. The pound is flying on a wing and a prayer—Brexit will punch it in the nose again—and nearing red resistance. It should wend its way back down to the channel bottom—but instead we got an upside breakout on the snap election news. See the chart.

The US 10-year yield should be bottoming on dismay over the Trump reflation trade suffering—but not below levels from before the election, right? And sure enough, on Monday the yield recovered a bit, to 2.252% from the worst-case 2.02% last Thursday—but it’s down again so far this morning. Even the Other Dollars, the flaky USD/ CAD (whose channel is dead flat since the March 15 crash) and the AUD should suffer as the USD recovers from an oversold condition. After all, the Fed is in tightening mode.

But guess again. Granted, yesterday the European markets were closed but US traders simply didn’t want to buy dollars. A N. Korean missile strike into the Sea of Japan could keep going and reach Japan itself next time, and yet the yen remains firm, if pulling back today. How are the yen or Japanese equities a safe haven when Japan could be a target? But the Nikkei closed up 0.35% overnight. Similarly, the May snap election announcement tanked sterling for only one hour.

Markets are having a hard time reconciling conflicting US economic data, too. Hard data is flat or lower, as we saw with retail sales and inflation last Friday. And yet soft data, like consumer confidence, keeps ballooning. See the chart from the FT.

The FT also reports the break-even rates for 1, 5 and 10 years are all at the low of the year, meaning inflation expectations are sliding back on the apparent postponement of Trumpian growth-boosting reforms. Even Fed funds futures point to delay—the probability of the June hike fell to 46.6% now from 54.8%, according to the CME Fed watch tool. One camp says gloom will keep piling on (lower yields) while the other camp says complacency is not warranted—something can still happen to goose the US economy and we may not need to wait for Congress to return from its 2-week recess.

Bottom line? There is no bottom line, at least not today. As a general rule, when in doubt, sell dollars. We continue to think the massive positive sentiment toward the Trump reflation trade is not dead or even dying. But until it gets a boost, the safe tactic is to get out of Dodge.

Politics 1: The US is not the only place where political uncertainty clouds sentiment. Bloomberg has a piece by El-Erian suggesting that Erdogan’s referendum win in Turkey is a precursor to a possible LePen win in France. El-Erian is often wrong but usually insightful. He says the populist surge leading to dictatorial powers is not to be downplayed. “… neither markets nor political scientists should underestimate what some swing voters are willing to accept, and risk, in their quest for greater national strength, a development that raises interesting domestic and global issues -- including possibly in the upcoming presidential elections in France.” Melenchon and LePen are “tail risks” but Macron, if he is the winner, has a lesson to learn.

Politics 2: Voters are out in force at town hall meetings while Congressmen are home on the spring recess, chiefly protesting Trump continuing to decline to disclose his tax returns. Libs are overjoyed and Congressional Dems are taking heart that they can justify declining to work on tax reform until we know how Trump will benefit, but let’s be realistic—this is bread and circuses. If the Plubs can get their act together, they can steamroll right over the Dems.

Politics 3: We still do not have a good grip on whether a US-N. Korea war would be good or bad for the dollar. Let’s be clear—we do not expect outright war. Most analyst believe we will limp along as we have since the 1950’s—sometimes talks and sometimes sanctions.

But we have two new leaders and the answer lies in how the two leaders behave. Trump has said “no more nuclear testing or else.” Kim can’t lose face by going along with that but we don’t know what the Trump punishment would be. Trump doesn’t know, either—there is no Trump policy.

Trump pretends that not showing his hand is clever but hardly anyone believes he knows what he is doing or should be doing. Trump’s cluelessness is revealed by blaming everything on Obama, which shows the extent of his ignorance. In reality, we could be blaming Bush Two, Clinton, Bush One and Reagan and Carter while we are at it—that’s how long the impasse has been going on. Chances are it will still be going on when Trump leaves office, too.

Negotiation is the alternative to war. How do you get negotiation between two bullies? Trump may (or may not) be a good deal-maker but he is hardly renowned for negotiation, which is another kettle of fish entirely. In deal-making, the other side is an adversary. In negotiations, the process is by definition non-adversarial. This is why, weirdly, senior military guys are better at negotiating than lawyers. In negotiation, you need trust and good faith on both sides. Right from the get-go, negotiation with N. Korea is virtually impossible. Somebody once said this is why women should run foreign affairs—far less testosterone.

In the US-N.Korean showdown, all the outcomes are bad. Seriously, there is no good outcome. There is the least-bad outcome of talks, which VP Pence is pushing, that lead to a moratorium and inspections by the International Atomic Energy Agency. But the last time, in the 1950’s, talks went on for two years. The two sides spent six months just deciding the shape and size of the table. You can’t help thinking about Hawkeye crashing the talks on the TV show MASH. Trump has never displayed any penchant for that kind of patience. And let’s not forget that one bullet fired over the DMZ is an act of war on South Korea, a country the US is treaty-bound to defend.

One problem with talk of war is, frankly, that the hawks are better talkers. Liberals/progressives don’t actually have anything of strategic value to add. If you like a strong argument, it’s hard to resist becoming a neo-con. This is why Israel’s Netanyahu is so compelling. It was not good form for him to invite himself over to address Congress during the Obama administration, but boy, can that man spin an argument!

 MacArthur was prescient—he wanted to keep going into all the North and maybe a step or two into China. He was about to exceed his authority and Truman had no stomach (or authorization from Congress) to make war with China, so Truman fired him. But how much better off we would all be without North Korea, including the North Koreans.

And this time, both China and N. Korea have nukes and N. Korea threatens to use them if the US goes a step too far. The only peaceable solution is something akin to the Iran deal whereby international inspectors check the N. Korean facilities, and to get that far will absolutely take China twisting the N. Korean arm with maybe a knife at the throat, too. It’s not clear China is sincere about linking up with Trump on the N. Korean problem. Whatever the Chinese say to his face, Chinese state-owned news outlets ridicule Trump.

Why would N. Korea ever go along with talks? Apart from Chinese threats we will never know about, N. Korea could be motivated by the understanding that nukes are a deterrent and not actually to be used. Besides, depending how many they have, using any at all ends their deterrence capability. The US and allies would (presumably) destroy the remainder, along with bombing Pyongyang back into the dark ages. Then why have they sacrificed for decades? That’s the stick. The carrot is obvious—ending sanctions, gifts of US food, machinery, technology, etc. The N. Koreans have blackmailed the West before. Heaven knows the people could use some food, not that the leadership gives a hoot about the people. Several countries have been strong-armed over the years into giving up nuclear ambitions, including Ukraine, Brazil and S. Africa. Not such bad company.

What we know about N. Korea is pitifully little. We think we learned something from the Inspector O spy/crime novels (by James Church, pseudonym for a retired US spy). What we learned is that N. Korea is a grim, and sad, place. “

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