Markets

EURUSD left in technical limbo as markets in full holiday liquidity

EURUSD, S&P 500, VIX and liquidity:

  • Market perspective: EURUSD Bearish below 1.0550
  • We enter the final week of the trading year with tough seasonal expectations embedded in the conditions. Most assets have made efforts to normalize or break rigid technical patterns
  • The exception to the de-escalation into holiday conditions is EURUSD which is very provocative in its lowest five-day range since November 2021.

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We’re heading into the last trading week of the year and many market participants have already turned off their computers until the clock ticks over to 2023. Although we’ve experienced some unusual volatility and directional distortion from the major markets through December and into the 51st week of the year, the natural limit participation through this last week of trading carries far more weight. It does not suggest a sense of direction for risk-sensitive assets, but rather a reflection of a significantly reduced pace of potential for markets regardless of the compass direction they chose. In this environment, a narrow cross is a steady state and breaks are very restrained to move into trends. If we were to experience an extraordinary event, it would most likely have to evolve from the equivalent of a ‘grey swan’ or greater (a significant and global financial disruption that was considered a possible threat, but not in the immediate future).

That is the background of the market we are dealing with and this is how I will approach my assessment of the EURUSD. The world’s most liquid currency pair, the benchmark has found its way into congestion that can easily be described as “extreme”. The five-day historical range (as a percentage of the spot) is the smallest it has generated since November of last year. Quiet can be expected during this period, but this is at the extreme end of the spectrum despite the calendar. Activity levels are typically ‘reverting to the mean’, which means that they usually move to something of the norm. If there is a break of the 1.0660 to 1.0580 range, it is unlikely to take place with significant follow-through. The 10-day moving ATR (realized volatility) is significantly hampered by market conditions and there is not much in the way of high risk from events in the US or Europe. I’ll wait for the break, but I’d be very skeptical about how far we can go from there.

EURUSD chart with 20 and 100 day SMA, 5 day historical range (daily)

Chart Created on Tradingview Platform

In terms of projected risk from fundamental events through the end of 2022, last Friday’s PCE deflator was perhaps the last significant release. The Fed’s preferred inflation reading slowed from 6.1 to 5.5 in the headline, while the core reading matched expectations for a decline from 5.0 to 4.7 percent. Both are still well above the Fed’s target rate, but the pace of the slowdown mirrors that of the market’s preferred CPI — which caused significant speculative gains in the S&P 500 in November and this month (at least initially). However, the market is generally paying more attention to the consumer price index reading, and the severe lack of liquidity in Friday’s final trading session was naturally a serious impediment to response. For the risk of planned events in the coming week, the weight of the US calendar will be around inventories, home inflation and pending home sales released midweek. Japan will be another region with fundamental strength, boosted by the recent surprise from the BOJ, with the BOJ’s summary of views alongside a range of monthly reports (housing starts, industrial production, unemployment and retail sales).

The biggest risk from macroeconomic events until the end of the week

Calendar Created by John Kicklighter

For the overall development of the ‘risk trend’, the seasonal averages suggest that there is likely to be a significant further outflow in liquidity and volatility levels. Considering the direction – where most traders are focusing – the historical average for the S&P 500 suggests that the last week (52nd) of the year results in a significant gain. In fact, it is the third largest in the second half of the year. However, the range of historical performance for this particular week throughout history is wide. Just to put that into perspective, it posted a modest loss last week when it has historically averaged a 0.3 percent gain. Direction is far less consistent than volatility and certainly liquidity over time.

Chart of S&P 500 Average Performance by Calendar Week Back to 1900 (Weekly)

Chart created by John Kicklighter

Given that the general direction of the market is unpredictable as liquidity conditions are more reliably released going forward with a possible increase in volatility, I will be watching the S&P 500 test the limits of its last week’s range. There is significant resistance above in the 3,910-25 area blocked by the 100-day SMA to the range of former lows in November and early December. Lower, we have 3,820-00 formed by a confluence of significant Fibonacci levels. We ended last week in the middle of this range, but volatility fueled by liquidity could lead to potential multiples to the limits of this range.

S&P 500 Emini Futures chart with volume, WIX and 20-day ATR (daily)

Chart Created on Tradingview Platform

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