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We all know that the forex and stock markets are related, so it's of course a good idea for forex traders to keep an eye on what equities are doing. But there are a couple of circumstances that are coinciding this quarter that make this relationship especially pronounced. The stock market, particularly in the United States, could give us some insight into what to expect in the currency markets.

What's going on?

To get a better understanding of the situation, we have to remember that one of the key ways the stock and currency markets are connected is through bonds. When bond prices fall, for example, then investors pile into that currency to buy. This pushes up the price of the currency with respect to others. At the same time, investors leave the stock market to buy bonds as well. This means the stock market goes down.

Hence, the standard inverse relationship between currencies and the stock market. Now, that doesn't always line up exactly, because it depends on why the price of bonds have gone down. The other main factor is risk sentiment. Stocks are higher risk, so investors will get out of the stock market and buy bonds when there is a risk-off market.

What's driving the underlying market

The issue is that the bond market right now is highly distorted, particularly in the US and Japan. This is because over the last couple of years, the regulators have been intervening in the market. Almost all central banks and governments have done this, but some more than others. Which is why there could be a discrepancy in the reaction from currencies.

During covid, governments issued massive amounts of debt in the form of bonds. That would normally force the interest rate higher, due to supply and demand. But central banks stepped in to buy bonds in order to force interest rates down. That creates an artificial situation in the bond market.

Tracking the distortion

The natural situation is that bond yields represent relative risk. That means the longer the bond term, the higher the interest rate. This is called the "bond yield curve". But central banks have stepped in to "control" the yield curve, such as the BOJ, or the BOE. The US bond curve is "inverted"; that is, short-term debt has a higher interest rate than long-term debt, which reflects expectations of central bank policy.

Why it matters

Investors are going to put their money where they believe there is the best risk-reward ratio. Bonds are low risk compared to stocks, so the higher the interest rate, the more interest there is in selling stocks. If the central bank is distorting the market, then investors have a different incentive structure. This can lead to a run-up in stocks, like in 2020-2021 when conditions aren't so good; and then a drop in the stock market when conditions are improving, like in 2022.

So, central bank policy can outweigh economic data. The Fed is expected to slow or stop its rate hikes sometime this quarter. With the Fed keeping policy steady, then the natural dynamics of the market could return. Which means the stock market could return to its more usual role of forecasting sentiment. Which in turn provides insight into how much demand there is for bonds, and whether or not a currency in particular will appreciate or weaken.

After trading in a rollercoaster manner in 2022, oil seems to be starting the new year between a rock and a hard place as the outcomes of ongoing market-related themes could end up working in favor of it or against it. In other words, the risks surrounding the black liquid are two-sided, and it remains to be seen which will prevail in the weeks and months to come.

Oil trades in rollercoaster fashion in 2022

Oil prices finished 2022 slightly in the green, with WTI and Brent crude oil futures adding yearly gains of around 7% and 9% respectively. However, these numbers are not telling the whole story. From around $75 per barrel, WTI shot up to around $130 in the aftermath of Russia’s invasion of Ukraine, reversing south soon thereafter as sky-high inflation and aggressive tightening by major central banks sparked fears about a global recession and thereby concerns about weaker demand for the black liquid.

Entering 2023, oil seems to be trading between a rock and a hard place, as the current landscape and potential responses to expected developments could drive prices either way.

Is the reopening of China a positive development?

Getting the ball rolling with China, in early December, investors cheered headlines of a gradual easing of COVID restrictions and a reopening of the world’s second largest economy. Oil prices joined the party and rebounded from a nearly one year low on hopes that demand from the world’s top crude importer could be restored.

That said, with COVID infections soaring in many districts, the optimism faded fast. Investors became worried that, let alone the risk of reversing relaxations, the Chinese economy may take much longer to recover. There are also increasing concerns about the risk of new variants spreading to the rest of the world, resulting in economic complications elsewhere as well and thereby more reduction in fuel consumption. And all this as major economies, like the EU, the US, and the UK, are already considerably wounded.

What about the cap on Russian oil?

Apart from China’s reopening, the cap imposed by the G7 nations on Russian oil is another double-edged sword. Following the verdict, Russia decided to ban the supply of oil to nations that will abide by the cap for five months starting in February, which is supportive for prices.

Nonetheless, given that more Russian oil is now shipped to China, Turkey, and Indonesia for refining and that there are no restrictions for the US and Europe on importing petroleum products made with Russian oil outside Russia, any gains in oil prices from Russia’s banning may be limited and short lived.

US reserves, OPEC, and winter also variables in the oil equation

Another source of demand may be the US’s decision to replenish its strategic petroleum reserve after selling record amounts, while the list of arguments pointing to a limited recovery includes the possibility of OPEC reversing some of its production cuts announced in November, as the cartel’s own projections point to increasing demand in 2023.

Winter is also a variable in the oil equation. EU nations’ ability to pile up oil before Russia’s retaliating measures take full effect and a mild winter so far have allowed oil prices to stay in downtrend mode. However, should winter get colder in the coming months, demand for heating oil could increase and thereby lift prices.

Outlook seems blurry for now

Blending everything together, the short-term outlook of oil looks blurry for now. Having said that though, what appears to be a clearer case for the next months is that a sustained uptrend may be off the books. Even if the Chinese economy recovers faster and oil demand is restored, and even if supply tightens more due to Russia’s decisions, a strong recovery in oil prices could well refuel inflation.

Should the central banks respond by re-accelerating and extending their tightening crusades, the global economy is very likely to fall into a deeper recession than currently estimated, which would eventually weigh on oil prices due to speculation that demand for energy could be dented again. A rebound in the US dollar as it reclaims the throne of the ultimate safe haven may also weigh on oil.

Now, if the surging infections in China result in more economic complications and the reopening of its borders more spreading of the virus to the rest of the world rather than spurring an economic recovery, oil prices may come instantly under pressure, with WTI perhaps falling below $70 per barrel.

Technical analysis still points to a downtrend

From a technical standpoint, WTI crude oil remains below the long-term uptrend line taken from the low of April 28, 2020, below the downtrend line drawn from the high of June 14, and below both the 50- and 200-day exponential moving averages. On top of that, last week, the black liquid came under selling pressure after hitting the short-term downtrend line, which implies that the bears may not have said their last word, despite allowing a rebound at the start of this week.

Should they overcome the low of December 9 at 70.40, a lower low would be confirmed and the trend may extend towards the low of December 2, 2021, at around 62.50. If that zone does not hold either, additional declines may result in the test of the 57.00 barrier, marked by the low of March 23, 2021, or even challenging the 51.50 zone, which provided support during January that year.

A decent recovery may be triggered upon a break above the 83.30 hurdle, which provided resistance on December 1 and support in October. Such a break could also take the price above the downtrend line and may allow advances towards the round number of 90.00 or the key resistance zone of 93.70, marked by the highs of October 7 and November 7 respectively. Slightly higher lies the peak of August 30 at 97.80 and the prior longer-term uptrend line, which may act as a strong resistance and confirm the hypothesis that any near-term recovery in oil prices is unlikely to lead to a sustained uptrend.

A meaningful uptrend may be a theme for the second half of 2023, conditional upon further cooling in inflation (especially underlying metrics), the end of the latest tightening crusade by major central banks, and signs of economic recovery worldwide.

The Japanese yen is calm on Monday and is trading slightly higher, at 132.27. The yen ended the week on a strong note, posting gains of about 1% on Friday.

USD/JPY has shown significant volatility since late December. Last week, the pair traded in a range of over 500 points, which included breaking below the 130 line for the first time since May. We could see stronger movement again today, as Japan releases Tokyo Core CPI and Household Spending later in the day.

Tokyo Core CPI expected to rise to 3.8%

Tokyo Core CPI has been moving steadily higher since January 2022, when it came it a negligible 0.2%. The December report rose to 3.6%, up from 3.4%, and the upward trend is expected to continue, with a forecast of 3.8% for January. After years of deflation, rising prices have become the new norm. The Bank of Japan has repeatedly stated that it will not change its ultra-loose policy due to higher inflation. Governor Kuroda said last month that he expects inflation to fall below the 2% target as the effect of soaring import costs will ease. The BOJ shocked the markets in December by widening the yield curve band, and there is speculation that Kuroda’s successor, who will take over in April, could raise the yield targets on long-term bonds, which would be a major policy change.

High inflation has taken a bite out of Household Spending, which fell to 1.2% in October, down from 2.3% a month earlier. The downtrend is expected to continue, with a weak gain of 0.6% expected for November.

The US dollar was lower across the board on Friday, after the US posted some soft data. Nonfarm payrolls was slightly better than expected at 223,000, but wage growth headed lower. Average hourly earnings rose 4.6%, well off the 5.0% estimate and shy of the prior reading of 4.8%. The ISM Services PMI underperformed, slipping to 49.6, down sharply from 56.5 and the forecast of 55.5. This marked the first time the PMI has fallen into contraction territory since May 2020, with a reading below the neutral 50.0 threshold. The drop in wages and the weak services data indicate that the US economy is slowing and is likely to tip into recession, which could force the Fed to reconsider its aggressive rate-tightening policy.

USD/JPY Technical

• There is weak support at 132.13, followed by 131.14
• 133.28 and 134.75 are the next resistance lines

The dollar index remains at the back foot on Monday and pressuring key supports at 103 zone (lows of mid / late Dec, where a temporary base has formed) after strong fall on Friday (down 1.1% for the day).

The dollar came under increased pressure after US labor data signaled that the Fed may further ease its stance on interest rates, while China’s further easing of strict Covid policy, added to improving risk sentiment.

Daily studies returned to bearish configuration, contributing to weakening tone, though fresh bears need to register a clear break of 103 support zone, which would also confirm penetration into rising weekly cloud (top of the cloud lays at 103.64) and signal continuation of the downtrend from 114.72 (2022 high, the highest since 2002) which paused for consolidation in past two weeks.

Sustained break of 103 zone pivots (also bull-trendline off 89.50, May 2021 low) would risk drop towards 101.94 (50% retracement of 89.15/114.72 ascend), 100.44 (weekly cloud base) and 100 (psychological).

Initial resistances at 103.95 (10DMA) and 104.11 (20DMA) should ideally cap, but extended upticks should not exceed 105.41 (Friday’s high (Fibo 23.6% of 113.02/103.06) to keep larger bears intact

Res: 103.95; 104.11; 104.52; 105.41.
Sup: 103.06; 102.63; 101.94; 100.44.

Cable continues to benefit from rising expectations for more dovish Fed after US labor data on Friday added to signals that the central bank would further ease the pace of policy tightening, increasing the possibility for 25 basis points hike in the next meeting and lowering expectations for 0.5% hike.

Sterling rallied 1.6% on Friday, after US labor data added to a risk sentiment, making the biggest daily rally since Nov 10, with formation of bullish engulfing pattern on a daily chart, generating initial bullish signal.

Monday’s extension hit the highest since Dec 21 and broke through Fibo barrier at 1.2144 (50% retracement of 1.2446/1.1841), signaling formation of a higher low at 1.1841, after the pullback from Dec 14 high (1.2446) was contained by rising thick daily cloud.

Improving daily studies (momentum is about to break into positive territory and moving averages returned to bullish setup) underpin near-term action, which looks for a daily close above broken Fibo level (1.2144) to keep bulls intact for further retracement of 1.2446/1.1814 pullback.

Next pivots lay at 1.2215 (Fibo 61.8%) and 1.2304 (Fibo 76.4%) violation of which would expose key barrier at 1.2446.

Extended dips should find ground above 1.2100 zone (last week’s multiple highs) to maintain bullish bias.

Res: 1.2174; 1.2215; 1.2241; 1.2304.
Sup: 1.2100; 1.2072; 1.2044; 1.2012.

In an economic bulletin article, ECB said, "Looking ahead, wage growth over the next few quarters is expected to be very strong compared with historical patterns."

"This reflects robust labour markets that so far have not been substantially affected by the slowing of the economy, increases in national minimum wages and some catch-up between wages and high rates of inflation."

"Beyond the near term, the expected economic slowdown in the euro area and uncertainty about the economic outlook are likely to put downward pressure on wage growth."

Full article here.

Eurozone unemployment rate was unchanged at 6.5% in November. EU unemployment rate was unchanged at 6.0%.

Eurostat estimates that 12.950m men and women in the EU, of whom 10.849m in the Eurozone, were unemployed in November 2022. Compared with October 2022, unemployment increased by 10k in the EU and decreased -by 2k in the Eurozone.

Full release here.

Eurozone Sentix Investor Confidence improved from -21 to -17.5 in January, slightly below expectation of -17.0. That's nonetheless the highest since June 2022. Current Situation Index rose from -20.0 to -19.3, highest since last August. Expectations rose from -22.0 to -15.8, highest since last February.

Sentix said: "Investors are still assuming a recession, but it is expected to be much milder. The sharp economic downturn, which was expected by the majority of investors by October 2022, is therefore off the table (for now)...a

"Overall, the economic environment remains challenging. The latest increases should not be misinterpreted as a general turnaround. The risks of recession remain."

Full release here.

• EUR/USD has reached a critical spot, which will determine whether the long-term outlook remains bearish or whether the trend will switch to bullish.
• The GBP/USD is showing strong bullish price action as well. The strong monthly candlesticks are indicating that the Cable could go higher before finding resistance.
• The NGAS chart has made a strong downtrend continuation - as we expected in our regular Elliott Wave updates on NGAS in 2022.

Our weekly Elliott Wave analysis reviews the EUR/USD daily chart, the GBP/USD monthly chart, and the NGAS daily chart.

EUR/USD downtrend in serious danger of reversal

The EUR/USD has reached a critical spot, which will determine whether the long-term outlook remains bearish or whether the trend will switch to bullish:

1. The EUR/USD is testing the key 38.2%-50% Fibonacci resistance zone (purple levels).
2. But the bullish price action is surprisingly strong and impulsive, which indicates a potential wave 3 (pink).
3. Until now we have labeled the bullish price swing as a wave C (pink), but the shallow corrective price action is indicating a wave 4 (pink) pattern.
4. The shallow price action is because price has bounced at the 23.6% Fibonacci support level of the purple price swing.
5. A bullish breakout (blue arrow) above the resistance (orange) could confirm a wave 5 (pink) of a larger wave A or 1 (gray).
6. A breakout below the 38.2% Fibonacci support level (purple) of the wave 3 could indicate that the ABC (pink) correction is valid (not the 12345).
7. If the price action does break north, then it could indicate the pause or end of a long-term downtrend and a larger bullish correction or uptrend.

GBP/USD bears losing control of the trend

The GBP/USD is showing strong bullish price action as well. The strong monthly candlesticks are indicating that the Cable could go higher before finding resistance (orange line):

1. The GBP/USD Elliott Wave count has remained bearish since the decline started at the top where wave 4 (pink) has ended.
2. But the bullish price action followed by the weak bearish reaction could indicate that the downtrend might be finished.
3. In that case, the lower low could complete a wave 5 (pink) of a wave 5 (gray).
4. Another bullish push higher could confirm a wave 1 (pink), after which we expect a bearish wave 2 (pink).
5. The support zone (green box) is expected at the previous lows, which could create a long-term inverted head and shoulders reversal chart pattern.
6. The bearish outlook could remain intact if price action is able to break below the 1.17 support zone.

NGAS falls down quickly in bearish impulse

The NGAS chart has made a strong downtrend continuation - as we expected in our regular Elliott Wave updates on NGAS in 2022:

1. The NGAS chart’s downtrend is expected to be a wave 3 (green) because of the strong impulsive decline.
2. The wave 3 (green) could continue lower. A small retracement (blue arrow) could follow up with another bearish swing lower (red arrow) before the wave 3 (green) is finished.
3. Eventually once the wave 3 (green) is completed, a larger bullish correction should emerge within a wave 4 (green).
4. Usually waves 4 are complex and lengthy, but eventually a new push lower within the wave 5 (green) of wave C (pink) of a potential wave W (gray).

The analysis has been done with the indicators and template from the SWAT method simple wave analysis and trading. For more daily technical and wave analysis and updates, sign-up to our newsletter

On the current USDCAD chart, we see the internal structure of a large correction pattern similar to a cycle triple zigzag w-x-y-x-z.

Perhaps the first four parts of this construction are fully completed, and now the final actionary leg is being built – the sub-wave z. Apparently, the wave z takes the form of a primary double zigzag Ⓦ-Ⓧ-Ⓨ, where the sub-waves Ⓦ-Ⓧ are formed.

Thus, at the moment it is possible that the last actionary primary wave Ⓨ is under construction.

It may end in the form of a double zigzag (W)-(X)-(Y) near 1.403. At that level, cycle wave z will be at 161.8% of cycle wave y

According to an alternative, the formation of a cycle triple zigzag could be fully completed. Therefore, now the initial part of a new bearish trend can be built.

We assume the construction of a primary double zigzag Ⓦ-Ⓧ-Ⓨ, which is the beginning in a larger correction pattern.

It is likely that the primary waves Ⓦ-Ⓧ-Ⓨ are already over.

In the near future, we can expect a continuation of the bearish primary wave Ⓨ, which may take the form of a double zigzag (W)-(X)-(Y) and end near 1.313. At that level, it will be at 76.4% of primary wave Ⓦ.