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Yen, Franc and Dollar Could Benefit as Market Optimism Shows Signs of Fading

FX Strategy

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- Indications from several markets that risk is reversing

- Markets may become more cautious

- FX winners: JPY, CHF and USD, losers AUD and NZD

Recent market optimism may be fading with implications for FX markets, according to Matt Simpson, a market analyst at Forex.com.

The recent run of good news about U.S-China trade relations, as well as a breakthrough on the Brexit front, had improved the outlook for global growth, spurring rallies in riskier assets, as investors once again dared to ‘dip their toes back into the wider asset mix.

The run of good news may be about to turn, however, says Simpson, as several markets are waving red warning flags.

If risk fades it should help the safe-havens like JPY, CHF and USD, whilst weighing on commodity currencies like AUD and NZD.

This also comes after mixed news from the UK where initial enthusiasm at Parliament’s backing of Boris Johnson’s deal ebbed away when MP’s decided to put a brake on his proposal to ‘fast-track’ it through by October 31.

The delay now throws everything back into chaos, although the chances of ‘no-deal’ now seem negligible.

Evidence of falling risk appetite has come from several different quarters, increasing the probability that together they may be giving a valid signal.

One source is U.S. equity indices, which are a leading barometer of risk as stocks and shares are seen as a relatively risky investment.

Here Simpson notes how the Nasdaq 100 tech index and S&P 500 broad index both posted bearish reversal bars, also known as candles, on their price charts recently, which could be indicating a reversal.

“The Nasdaq 100 produced an elongated, bearish outside day and its third bearish candle over the past four,” says Simpson. “Whilst the magnitude of the on the S&P 500 was not as severe, it was a bearish engulfing candle nonetheless.”

Equity signals on risk

Another proven measure of investor sentiment is the Japanese Yen, which trades like a safe-haven asset, rising when the market gets jittery and falling when confidence is high.

It too is showing signs of reversing from previously falling and starting to rise, indicative of renewed safe-haven flows.

The chart below shows the relative performance of four yen pairs which are particularly sensitive to market sentiment.

Daily

It shows how all 4 pairs have started to reverse trend after a run of strength. This is a sign the Yen is starting to strengthen again as investors turn cautious.

The price charts of key yen pairs are also displaying signs of a reversal after forming bearish configurations circled below.

These include bearish candlestick patterns from the ancient Japanese art of candlestick analysis with poetic names like ‘shooting star’, ‘bearish engulfing’, ‘dark cloud cover’ and ‘evening star reversal’.

Several of the pairs have also reached the top of channels complementing the bearish signal from the candlesticks, since when prices hit channel tramlines they often get rebuffed.

Yen

Whilst the market is giving signs investor mood may be growing more pessimistic it should be borne in mind that the indications are only for a temporary dip in spirits.

“It’s worth noting that price action on the above crosses are in an uptrend, so any reversal from these levels points towards a correction and, therefore, a temporary bout of risk-off,” says Simpson.

Elsewhere, strategists at HSBC say they see the recent positive run for risk-on assets coming to an end.

“We believe fading the risk rally remains appropriate, especially as some of the moves in G10 FX leave a number of currencies at the strong end of recent ranges,” says Daragh Maher, head of research at HSBC.

Maher thinks the recent recovery in NZD and AUD is unsustainable.

Yet both are highly positively correlated to greater market risk appetite so if he is right and they are set to weaken it could also suggest a broader change in mood, in line with Forex.com Simpson’s view.

"Despite more positive global news flow, the conditions that have kept antipodean currencies in a gradual downtrend remain intact," says Maher.

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