Emerging Currencies Fall

From the desk of Steven Strazza @Sstrazza and Ian Culley @IanCulley

At the beginning of the month, we pointed out the disconnect between risk assets and the currency market. 

Stocks up and down the cap scale were breaking out to new highs and energy futures were resolving higher from multi-year bases -- all while emerging-market and commodity-centric currencies approached year-to-date lows.

Something wasn’t right. 

We’d expect these risk-on currencies to catch higher given their strong correlation with other risk assets. But this hasn’t been the case. In fact, seeing as currency markets had been out of sync with other asset classes for months, we really didn’t want to overthink this development.

But what appeared to be another mixed intermarket signal proved a valuable warning.

Fast-forward to today and the weakness that was evident among emerging-market currencies is spreading to stocks and commodities. Small-caps and crude oil are retesting critical breakout levels, and cyclical stocks are failing to sustain their recent moves.

In today’s post, we’re going to check back in on the Emerging Currency ETF $CEW and highlight a trading opportunity in the forex market.

Let’s dive in!

Here’s a daily chart of CEW showing its recent breakdown to new 52-week lows: 

Earlier in the month, we wanted to sell weakness below 17.70 with a tactical downside target of 17.15. Now, just a few weeks later, our initial downside objective is within reach.

Here’s what we had to say about it in our post from a few weeks ago:  

If the Emerging Currency Fund ETF is losing a crucial support level, we’d imagine that weakness is spilling over to more and more individual crosses.

And that’s exactly what we’re seeing now.

In early November, we featured developing setups in the USD/BRL and USD/MXN crosses. Today, we’re going to highlight a breakout in the USD/ZAR pair.

Below is the daily chart of USD/ZAR completing an inverted head and shoulders on its way to new 52-week highs:

The USD/ZAR is a prime example of a forex cross jibing with the weakness in cyclical stocks. We want to buy this base breakout against 15.50 with a 1-3 month target of 17.08. On the other hand, we can’t be long if this cross slips back below our risk level and into its prior range.

Whether risk assets dig in and find support in the coming weeks is yet to be seen. 

Regardless of the outcome, our best course of action is to continue to trade what’s in front of us, analyzing each chart based on its own merit. As always, our focus needs to center on risk management, and we do not want to overthink the intermarket landscape.

With that said, the weakness coming from commodity-centric risk-on currencies does not bode well for the global growth/reflation trade in the near term.

We want to sell some of the weakest emerging-market currencies against the dollar.

We’ll continue to keep you updated as the intermarket picture develops.

Stay Tuned!

Thanks for reading. As always, let us know what you think.

And be sure to download this week’s Currency Report!