Weekly look-ahead

By David Morrison  |  19/01/2018 16:30

This article looks at some key market breakouts and what to be aware of in the week ahead.

Summary

The last couple of weeks have brought significant technical breakouts in a number of markets. The Dollar Index has broken below key support while the EURUSD is consolidating above prior resistance around 1.2100. All the major US stock indices continue to trade around record highs while at the beginning of last week crude oil hit its highest level in over three years before turning lower. Meanwhile, US Treasury bonds continue to slide in a move which saw the 10-year yield hit 2.64% on Friday - its highest level since April 2014. As far as bond gurus Bill Gross and Jeff Gundlach are concerned, this should signal the end of the 35-year bull market in bonds. If so, then this will have significant implications for all financial markets going forward. Consequently, price action over the next few weeks could well set the tone for the rest of this year and beyond.

Key events

This week brings more corporate earnings, monetary policy meetings from the Bank of Japan and European Central Bank, the World Economic Forum in Davos, Manufacturing and Services PMIs from the US and across the Euro zone, UK Unemployment numbers and GDP. Rounding off the week we have US Durable Goods and Advance GDP.

Stock indices

Heading into the weekend global stock indices were looking robust and the US majors were holding near all-time highs. This was despite a rare wobble earlier in the week which was reversed quickly as traders rushed in to “buy the dip”. Apple helped to goose the market after it announced it would be making a $350 billion “contribution” to the US economy over the next five years, mostly as a result of Trump’s tax reforms. Even the most cursory look at charts of the US majors shows an explosive move higher since the beginning of this month. There seems little doubt that the current round of bullishness was triggered by the passage of the Tax Cuts and Jobs Act of 2017 which came into effect on 1^st January. Sentiment is also getting a boost from a strong start to the fourth quarter earnings season, despite some mixed results from the banking sector.

But the big question is just how much further can this rally go? The answer is that, for now, every piece of market news or economic data is used to justify further buying. One day that will change and the resulting sell-off will be ugly. But it’s impossible to forecast when that time will come, although it seems likely that a reduction in monetary stimulus will prove to be the trigger.

The European majors had a mixed week although the German DAX was also closing in on its own all-time high hit back in November. Investors shrugged off the negative effects of the strong euro on German exporters, focusing instead on hopes that the country would soon have a functioning coalition government.
 
FX

On Friday afternoon the Dollar Index was on course for its fifth successive negative week which would mark its longest losing streak in over two and a half years. The downside momentum accelerated after the EURUSD broke and held above significant resistance around 1.2100. This saw the greenback continue the near-unbroken slide which began just over a year ago. The only let-up coming with a modest corrective bounce between September and November. The dollar sell-off comes despite a rally in bond yields which saw the US 10-year Treasury yield hit its highest level since 2014. Usually higher US yields mean a stronger dollar. Investors are betting that the rate of economic growth across the Euro zone and Japan is set to outpace that of the US. They also expect the supply of US dollars to outstrip future demand.
 
A fortnight ago German Chancellor Angela Merkel appeared to have formed a workable coalition with her former partners the SPD. However, as of Friday negotiations were still ongoing with hopes that the weekend may see a positive conclusion to talks. Despite this uncertainty last week saw the EURUSD broke above 1.2300 to hit its highest level in over three years.

Also last week the British pound came within one cent of 1.4000 to trade at its highest level since the UK’s vote to leave the EU in June 2016.  Sterling has also made gains versus the euro. However, the upside has been limited given the single currency’s recent strength. Overall, the pound’s rally has far more to do with the ongoing decline of the dollar. The question now is whether the greenback weakens further now helping sterling to take out major resistance around 1.4000.

Crude oil

Last Monday WTI and Brent crude hit their highest levels since December 2014. This was a continuation of the rally which began in June. However, prices have pulled back a touch since then as some traders have stepped in to book profits. This seems entirely sensible as net speculative positioning stood at an all-time record high the week before last. This on its own doesn’t mean that prices are set to fall. But it can be a warning that even a small downside move can turn into an avalanche of selling if speculators rush to bail out of their long positions. Fortunately for the bulls, this hasn’t happened so far. But the market does remain unbalanced, despite last week’s pull-back.
WTI (which is the more technically-traded of the two contracts) is currently consolidating above a significant area of support (previously resistance) around $62.50/63.00. If WTI can hold above here over the next few days, then technically it looks as if further gains are possible. As far as fundamentals are concerned, last week it was reported that OPEC’s December oil production rose to 32.42 million barrels per day (bpd), just below the mandated output ceiling of 32.5 million bpd. Venezuelan production fell by nearly 5% but this was offset by raised production from other OPEC members: Algeria, Angola, Iran, Nigeria and Kuwait. This should be supportive for the oil price as global inventories fall back towards their five-year average. Meanwhile, OPEC also revised up its estimates for 2018 oil demand growth to 98.5 million bpd, up from a forecast of 97 million bpd in 2017. Again, this should be positive for oil particularly as analysts factor in expectations for accelerated and synchronised global economic growth. On top of this US inventories (as measured by both the American Petroleum Institute and the US Department of Energy) continue to decline with crude stockpiles having now fallen for nine straight weeks. But countering all this bullishness was news that US shale production has picked up while there were significant builds in gasoline and distillate inventories. Overall, it feels that the oil price is balanced on a knife edge and could go in either direction over the next few weeks.
 
Gold

On Friday gold was on course to end the week lower which would mark its first week-on-week decline since the beginning of December. The pull-back was modest although it came despite continued weakness in the US dollar – something which typically is supportive of gold when priced in dollars. No doubt sellers crept in to take advantage of the 8% rally which has seen the precious metal retake levels last seen in September. Technically, gold has found some support around $1,330 – a level which roughly corresponds to the 76.4% Fibonacci Retracement of the September-December 2017 sell-off. But should this fail to hold this week there’s some solid support around $1,310 which marks the 61.8% retracement of the same move. As to the upside potential, so far gold hasn’t managed to retest September’s high of $1,357. But if it does then the next upside target is $1,375 – the high from July 2016. While this isn’t a million miles away, we’d need to see the dollar weaken substantially from current levels for gold to build the necessary upside momentum for such a move. 

Any information, analysis, opinion, commentary or research-based material on this page is for information purposes only and is not, in any circumstances, intended to be an offer of, or solicitation for, a transaction in any financial instrument. No representation or warranty is given as to the accuracy or completeness of this information. Any person acting on it does so entirely at their own risk and GKFX accepts no responsibility for any adverse trading decisions. You should seek independent advice if you do not understand the associated risks.