“Slow” but still steady.

After Chair Jerome Powell’s speech last Wednesday, markets are looking forward to the next FOMC meeting for confirmation of the “slow the pace of interest rate hikes” narrative.

A rally stoked by Powell’s comments has pushed the S&P 500 index to the top of the descending channel. This is the fourth time the upper resistance has been retested since the beginning of this year. If this pattern holds, we could potentially see the rally ejected once again, and the price may head lower after this local peak.

The recent weakening of the US Dollar in general, coupled with the potential of China opening up, has helped the Yuan gain some ground against the Dollar. The price action unveiled a Head-and-Shoulder (H&S) top pattern generally associated with major trend reversals. Furthermore, we also see USDCNH on the verge of breaking its 18-month uptrend support. This could very well spell the end of the rally for the pair as Dollar and Yuan drivers start to shift. 

The weakening greenback generally bodes well for commodities priced in USD. Dr Copper, as they call it, might just be the first to react to this weakness and set the tone for the rest of the industrial metals. A false break of the ascending triangle bottom sent the price back to the 0.236 Fibonacci line. Now it appears that copper is ready for another attempt at a break upward.

As the reality of winter sets in and the panic of the Russian-Ukraine crisis abates, heating oil seems to have found support near 3.2, which happens to be the same level it was trading at right around the start of the conflict. Any abrasive actions or a harsh winter storm could send heating oil on another leg upwards.

The Euro, which not too long ago traded below parity against the Dollar, seems to have set its sights on more. A clean breakout upwards from an ascending triangle generally signifies a bullish continuation. We have already seen a larger ascending triangle play out clinically, pushing the pair above the parity mark once in November. Will this smaller but similar setup prove successful for the Euro?

Chair Jerome Powell’s speech last Wednesday at the Brookings Institution in Washington has set the tone for the rest of the year. Media headlines, in general, seem to fixate on this sentence in his speech - “The time for moderating the pace of rate increases may come as soon as the December meeting.” Equity and bond markets rallied.

In our opinion, the line must be appreciated in the context of the entire paragraph, which reads:

“The time for moderating the pace of rate increases may come as soon as the December meeting. Given our progress in tightening policy, the timing of that moderation is far less significant than the questions of how much further we will need to raise rates to control inflation, and the length of time it will be necessary to hold policy at a restrictive level. It is likely that restoring price stability will require holding policy at a restrictive level for some time. History cautions strongly against prematurely loosening policy.”

The paragraph reads like a good novel with the teaser at the front on moderating the rate increase, followed by the main story that the moderation is only but a small shift in the path that is still upwards. As laid out in our previous edition, we hold the view that the battle with inflation is far from over. As long as the Fed does not prematurely loosen its policy, the economic conditions will remain tight, tipping the economy ever closer to a recession. With US treasury bonds offering relatively high risk-free yields, equity risk premiums are still not very attractive. These keep us cautious of the recent relief rally in equities.

Switching gears, another development to watch for is the easing of the Covid policy in China. With China being the biggest metals consumer, any meaningful change in its COVID policy could spark the next rally for copper, the commodity that generally leads economic cycles. With copper and the USDCNH trading at key levels now, we find these opportunities rather attractive.

We consider expressing our views via the following hypothetical trades¹:

Case Study 1: Short USDCNH Futures

We would consider taking a short position on USDCNH futures (CNHZ2) at the present level of 7.0350, with a stop-loss at 7.0800, which could bring us a hypothetical maximum loss of 0.0447 points. Looking at Figure 2, if the breakdown from the support and H&S top holds, USDCNH has the potential to fall back to 6.8350, a hypothetical gain of 0.2000 points. Each 0.0001 point move per USD in the USDCNH future contract is CNH 10.

Case Study 2: Long Copper Futures

We would consider taking a long position on copper future (HGH3) at the present level of 3.795, with a stop-loss below 3.5, which could bring us a hypothetical maximum loss of 0.295 points. Looking at Figure 3, if the rebound continues, copper has the potential to reach the 0.618 Fibonacci retracement level around 4.33, a hypothetical gain of 0.535 points. Each point move in the copper future contract is USD 25000.

¹ Examples cited above are for illustration only and shall not be construed as investment recommendations or advice. They serve as an integral part of a case study to demonstrate fundamental concepts in risk management under given market scenarios. Please refer to full disclaimers at the end of the commentary.

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