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Dow Jones contract for September delivery is heading into US session on Tuesday firmly in red, following day's start with gap lower after rising geopolitical tensions prompted investors from riskier assets. Fresh weakness on Tuesday generated direction signal after triple Doji on daily chart signaled strong indecision. Rising 55SMA (currently at 21621) which contained previous attempt lower comes under pressure again. Break below is needed to confirm lower platform at 21985 and expose next strong supports at 21499 (Fibo 38.2% of 20477/22131 upleg) and 21457 (top of rising daily cloud). Strong bearish sentiment is supported by negative setup of daily studies, as bearish momentum is building up and indicators heading south. Formation of Tenkan-sen/ Kijun-sen bear-cross is reinforcing negative near-term outlook. Bearish pressure is expected to persist while today's gap remains unfilled.

Res: 21727; 21800; 21895; 21921
Sup: 21621; 21580; 21499; 21457

The two key phenomena, tightening in liquidity condition and renminbi strength, in the Chinese market have persisted. Last week, PBOC auctioned RMB 80B of 3-month Treasury deposits at 4.51%, the highest since December 2014. This came in after another auction of 3-month Treasury deposits on August 18, at 4.46%. Higher interest rates signaled that the government is trying to increase the borrowing cost, tightening money supply. Indeed, liquidity conditions have remained tight in China, with both interbank rates and bond yields higher. Renminbi firmed, thanks to the broad-based weakness in the greenback and the Chinese government's capital control measures. USDCNY fixing has fallen to 6.6293, lowest level since August 2016, on Tuesday. The current liquidity environment and renminbi strength are in line with PBOC's "prudent and neutral" monetary policy stance, with the main goal of "deleveraging".

1. The Trend of Tighter Liquidity Conditions Continues

Overnight SHIBOR jumped to 2.92% on Tuesday, a level not seen since April 2015. This also marked a +7.1 bps increase from the prior day and +10.5 bps from the same period last year. Indeed, overnight SHIBOR has increased 175 bps in the first three weeks of August. The tightened liquidity condition has pushed bond yields higher. 5-year yields eased modestly to 3.65%, after soaring to a 2.5-month high of 3.652% on Monday, while 10-year yields also stayed high at 3.694%, after a rise to 3.702%, highest since May 11, 2017, on Monday. Note also that the spread between 10-year and 2-year government bond yields has narrowed recently. PBOC refrained from injecting liquidity to the market, draining a net RMB 330B, last week. We expect the liquidity would remain tight, if not tighter, in the coming month, as a record RMB 2.3 trillion in maturities of negotiable certificates of deposit (NCDs).

Negotiable Certificates of Deposit (NCDs)

One of the key areas of the government's deleveraging work is to curb NCDs which have mushroomed as a result of the accommodative monetary policies after the global financial crisis. The value of outstanding NCDs expanded to RMB 8.43 trillion as of July. NCDs contribute to 13% of total bond market in China this year, up from 1.7% in 2014.

Regulatory loopholes have made NCDs a popular way of financing for small banks (banks outside of top 10 by market value accounted for 76% of total sales) in China. The unruly manipulation of NCDs as a means of financing has resulted in a serious problem of asset liability maturity mismatches that the government seeks to tackle now.

The flowchart below illustrates the mechanism of NCDs. Small banks are keen on issuing short-term NCDs to large banks which are able to acquire funds at low cost in an environment of accommodative monetary policy. Upon acquiring the funding through NCDs, small banks then invest by purchasing NCDs issued by other banks and invest in wealth management products (funds, private equities, stocks, etc) which are usually longer-term investments. The problem of asset liability maturity mismatches appears here: the small banks make profits by issuing shorter-term NCDs and investing in longer-term instruments. However, they would fail to repay its debts to the large banks as they are bound by the longer-term investments. This has created a vicious cycle as the small banks have to keep issuing new NCDs for refinancing or they would have to sell their investments.

Although financial institutions are required to cap interbank liability at 33% of total liability, NCDs are not included although it has the same function as interbank liability. Therefore, NCDs have been virtually unregulated until recently. At the second quarter monetary policy report, PBOC pledged that NCD would be included in the interbank liability indicator in the macro-prudential assessment (MPA) from 1Q18 – treating NCDs as interbank liability.

As illustrated above, the root cause of NCDs is the easy money acquired by large banks. We expect the central bank to continue to maintain a relative high interest rate environment so as to increase the cost of issuing NCDs.

2. China Favors Renminbi Strength

Another phenomenon is the strength of renminbi, thanks to the broad-based weakness in the greenback and the Chinese government's capital control measures. USDCNY fixing has fallen to 6.6293, lowest level since August 2016, on August 29. We believe the government is in favor of a stronger renminbi, not only because it helps tightens the monetary policy, but also because it attracts foreign capital inflow.

Indeed, the government has continued its capital control measures so as maintain a relatively firm renminbi. The National Development and Reform Commission (NDRC) on August 18 issued new rules on foreign investments, introducing three categories, namely banned, restricted and encouraged of investments. According to NDRC, banned industries include those in the military, gambling and sex industries; restricted industries include those in real estate and hotels, film and entertainment, sports, and those that do not comply with environmental standards; and encouraged industries include those that promote the Belt and Road, improve China's technology or research and development, and those that expand oil, mining, agriculture and fishing. This marks another layer of restrictions over capital outflow.

We will be receiving the August FX reserve next week. We expect FX reserve to remain strong for another month. Given the weak USD, it is less necessary for PBOC to sell foreign currencies to support renminbi.

USD/CHF - 0.9457

Original strategy :

Sell at 0.9520, Target: 0.9420, Stop: 0.9555

Position : -

Target :  -

Stop : -

New strategy  :

Sell at 0.9520, Target: 0.9420, Stop: 0.9555

Position : -

Target :  -

Stop : -

As the greenback has dropped again after brief recovery, adding credence to our view that top has been formed at 0.9773 earlier and bearishness is seen for the erratic decline from there to extend weakness to 0.9400-10, however, near term oversold condition should prevent sharp fall below 0.9370-75 and reckon 0.9350 would hold from here, risk from there has increased for a rebound later. 

In view of this, would not chase this fall at current level and we are looking to sell dollar on recovery as previous support at 0.9537 should turn into resistance and limit dollar’s upside, bring another decline. Only above resistance at 0.9578-83 would abort and signal low is formed, bring a stronger rebound towards 0.9620.

Broad-based U.S dollar weakness provoked a bullish move above the 1.2920 level, however, sterling has been strongly rejected from 1.2979 level, which represents the GBPUSD pairs daily time frame, 50 period moving average.

At present, the pair is trading around the 1.2950 level, as traders await the start of the U.S trading session, with North Korea and a key speech Federal Reserve voting member Charles Evans in focus.

GBPUSD is strongly bullish on an intraday basis, with the pair now trading back above both 100-day and 200-day moving averages.

Technical resistance is found at 1.2980, while the1.3000 level offers strong psychological resistance. Above the 1.3000 level, the 50 percent Fibonacci retracement of the 1.2773 price low, to the 1.3268 high, is found at 1.3020.

To the downside, the M5 time frame, 200 period moving average is found at 1.2940. The 100-day moving average offers solid intraday support, at 1.2920, with the 1.2890 level acting as critical weekly support.

The single currency has broken above the psychological 1.20 level, hitting 1.2070, in a busy European trading session, that saw the euro move to a 27-month trading high against the U.S dollar.

During the upcoming U.S trading session, the euro may soon start to challenge to the 1.2100 level, as selling in the U.S dollar index accelerates, with the greenback now firmly technically and fundamentally bearish.

Going forward, if the EURUSD pair can hold price action above the key 1.2030 support level, buyers should take the pair for a further attempt at the 1.2070 level.

Key technical resistance above the 1.2070 level is located at 1.2100, 1.2120, with historical EURUSD Fibonacci resistance found at the 1.2160 level.

To the downside, the July 2012 price low is now critical EURUSD resistance turned support, at 1.2030. Below 1.2030, the 1.2000 level is strong psychological support, with the 1.1960 level now offering the foremost support below 1.2000.

GBP/USD - 1.2950

Original strategy :

Buy at 1.2920, Target: 1.3020, Stop: 1.2885

Position : -

Target :  -

Stop : -

New strategy  :

Buy at 1.2900, Target: 1.3000, Stop: 1.2865

Position : -

Target :  -

Stop : -

As cable surged again after finding renewed buying interest at 1.2873 yesterday, adding credence to our view that a temporary low has been formed at 1.2774 last week and bullishness remains for the rise from there to bring retracement of recent decline, hence further gain to 1.3000 and later towards previous resistance at 1.3032 would be seen, however, near term overbought condition should limit upside and reckon 1.3075-80 would hold from here.

In view of this, we are looking to buy sterling on pullback as 1.2900 should limit downside. Below 1.2895-00 would defer and risk test of said support at 1.2873 but only break there would signal first leg of upmove from 1.2774 has ended, risk weakness to 1.2840-50 but support at 1.2813 should remain intact, bring another rebound later. 

EUR/USD - 1.2032

Original strategy  :

Buy at 1.2000, Target: 1.2100, Stop: 1.1965

Position : -

Target :  -

Stop : -

New strategy  :

Buy at 1.1965, Target: 1.2065, Stop: 1.1930

Position : -

Target :  -

Stop : -

As euro’s upmove has accelerated after last week’s anticipated rally above previous resistance at 1.1910 (now support), adding credence to our bullish view that recent upmove is still in progress and may extend headway to 1.2070 and then 1.2095-00, however, near term overbought condition should limit upside and reckon 1.2150-55 (61.8% projection of 1.1119-1.1910 measuring from 1.1662) would hold from here, bring retreat later.

In view of this, would not chase this rise here and would be prudent to reinstate long on pullback as 1.1955-65 should limit downside. Only below 1.1930 would defer and risk test of support area at 1.1910-13 which is likely to hold from here.

Overnight, North Korea fired a missile that flew over Japan, violating the nation's airspace. This marked further escalation in the region's geopolitical tensions, which triggered a classic risk-off market reaction. Safe haven assets such as gold, the Japanese yen, and the Swiss franc rallied on the news, while major equity indices edged lower.

In the short-term, we expect market action to be driven by incoming headlines on the subject. Japanese PM Abe already called for fresh UN sanctions on North Korea, which we view as a "soft" and diplomatic approach. Nonetheless, key US officials (such as the President) have not yet commented on this latest show of force by the North Korean regime. If we were to see another round of hard rhetoric from the US administration, or some form of action, then risk-aversion could continue to drive markets. Specifically, gold and other safe havens could gain further, while riskier assets could remain under pressure. Having said that, unless the situation intensifies to the degree of military intervention, we don't expect this negative sentiment to remain the main market theme for too long.

Gold surged during the European afternoon Monday, to break above the key psychological barrier of 1300 (S2). The metal gapped further up during the Asian morning Tuesday after North Korea fired a missile over Japan to hit resistance at 1325 (R1). The price structure on the 4-hour chart suggests a short-term uptrend marked by the uptrend line taken from the low of 10th of July. Thus, we would expect a clear break above 1325 (R1) to set the stage for more bullish extensions, perhaps towards our next resistance level of 1340 (R2). The trigger for further advances may be further escalation in geopolitical tensions.

Having said that though, given that the latest rally appears overextended, and also taking account our proximity to the return line drawn from the peak of the 7th of July, we stay careful of a possible retreat before the bulls decide to take charge again. A dip below 1313 (S1) may confirm the case and is possible to open the way for a test near the 1300 (S2) zone as a support this time. Our short-term oscillators enhance our concerns. The RSI shows signs that it could top within its above-70 zone, while the MACD, although above both its zero and trigger lines, shows signs that it could start topping as well.

Zooming out to the daily chart, we see that the 1300 (S2) zone acted as the upper bound of the wide range the yellow metal has been trading within since the 31st of January, between that hurdle and the 1200 territory. As such, its clearing make us confident that the medium-term outlook may have also turned somewhat positive.

Daily Pivots: (S1) 1.1935; (P) 1.1959 (R1) 1.2002; More...

EUR/USD's rally extends to as high as 1.2069 so far. Intraday bias remains on the uprise for 61.8% projection of 1.1118 to 1.1908 from 1.1661 at 1.2149 first. Break there will target 100% projection at 1.2451 next. On the downside, below 1.1955 minor support will turn intraday bias neutral first. But retreat should be contained above 1.1661 support and bring rise resumption.

In the bigger picture, an important bottom was formed at 1.0339 on bullish convergence condition in weekly MACD. Sustained trading above 55 month EMA (now at 1.1768) will pave the way to key fibonacci level at 38.2% retracement of 1.6039 (2008 high) to 1.0339 (2017 low) at 1.2516. While rise from 1.0339 is strong, there is no confirmation that it's developing into a long term up trend yet. Hence, we'll be cautious on strong resistance from 1.2516 to limit upside. For now, medium term outlook will remain bullish as long as 1.1295 support holds, in case of pull back.

Daily Pivots: (S1) 1.2889; (P) 1.2915; (R1) 1.2959; More...

No change in GBP/USD's outlook as it's staying below 1.3030 resistance. Intraday bias remains neutral with mildly bearish outlook. We're favoring the case that correction from 1.1946 is completed at 1.3267. Below 1.2773 will target 1.2588 key near term support first. Decisive break of 1.2588 will confirm our view and target a test on 1.1946 low. Though, break of 1.3030 will dampen this bearish view and turn bias back to the upside for retesting 1.3267.

In the bigger picture, overall, price actions from 1.1946 medium term low are seen as a corrective pattern. While further rise cannot be ruled out, larger outlook remains bearish as long as 1.3444 key resistance holds. Down trend from 1.7190 (2014 high) is expected to resume later after the correction completes. And break of 1.2588 will indicate that such down trend is resuming.