Emerging Market FX: Policy Divergence Re-Emerging

The blowout US Non Farm Payrolls release on Friday has sparked a drive in the USD as markets expectations for a December rate move soared from 30% prior to the release to register a 70% probability post the data as the US delivered a headline payrolls number of 271,000 for October topping expectations and leaving players to chase the Dollar higher.

Fundamental Flow

The repricing of the potential of a FED move in December was felt sharply across Emerging Markets as the USD surge once again highlighted the dynamism of the Policy Divergence theme that has been the catalyst for the USD climb since the summer of 2014.

The policy divergence theme is most clearly demonstrated in the EMFX within the largest economy in the Emerging Markets; that of China. The domestic data from China continues to decline and paint and increasingly bearish portrait of slowing growth and fiscal failing that first came to the forefront during the late summer of this year.

Just this week China released export data which demonstrated a further contraction, more than consensus, declining to 6.9% YOY. The catalyst behind the less than stellar read is believed to be predominantly driven by continued weakness in Asian trading partner appetite, which dropped from a positive six percent reading in September to a negative ten point nine percent reading in October, this sharp reversal in local trading conditions was mirrored in sluggish readings from the Eurozone and Japan. The dire export data was exacerbated by import data that remains in the tank contracting to -19.8% YOY.

With commodity prices still under pressure dower domestic demand continues to weigh on import growth. The import and export data underlines the growing challenges for the Chinese trade sector and has many market watchers convinced that this latest in a long line of disappointing data will see China make another rate cut before year end, in stark contrast to the consensus view of the FED’s direction.

On Wednesday markets are poised for the next Chinese data dump, as retails sales figures will be released, industrial production data and inflation data will all hit the wires. An interesting point of note with respect to this data is that the consumer and services sectors are greatly overlooked as contributors to China’s GDP. While it is difficult to get a decent consensus market read on the numbers the popular expectation is for the the number to print unchanged at 10.9% YOY. While their is the possibility of an uptick on the production side of the slate market forecasts 5.6% YOY, the decline in commodity prices is likely to weigh on Consumer Price Index data.

Trading Take Away

The fundamentals proved sufficient to break the USDCNY out of the downward corrective channel we had been tracking. The reversal north manifested just ahead of the reversal zone we were tracking to engage long positions as you can see from the chart below that has the overlay of the probable price path we had in mind.

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So with the channel break, we must reassess the price patterns and identify the next high probability trading location. One of my go to trading set ups in this scenario is the snap back trade. The snap-back trade occurs when an established ascending or descending trend line is breached, I monitor the price action a for a quick retest of the trend line, dropping down to an intraday chart I look for a smaller time frame reversal pattern to engage the market in the direction of the original break.

So in this instance we were monitoring a bearish corrective channel where prices was trading against and respecting a downward sloping trend line, the upside breach suggests the potential for the correction to be complete. So now I am monitoring the price action looking for a relatively swift retest of the broken trend line resistance as support.

So as you can see in the chart below I have identified the trade level of interest 6.3452 and I will monitor this zone on intraday time frames looking for a reversal pattern to venture long, and I will use the low of the day of entry as a protective stop for this position.

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Open Emerging Market FX Trades

Long USDINR 65.25 Stops To Entry, First Target Achieved at 66.85, stay long to target a retest and break of year to date highs next

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For updates on trade of the day set ups and the other trades I am currently monitoring be sure to follow me on Twitter @LFXPatrick