Breakout Watch: Trading Nikkei Futures Ahead of Its Micro Launch1. Introduction: Nikkei Futures and Current Market Setup
Nikkei Futures (NIY1!) remain a cornerstone of Japan's equity market exposure for traders globally, offering insights and trading opportunities tied to the performance of Japan’s stock market. In recent days, the Nikkei Futures market has entered a phase of tight consolidation, with the trading range narrowing between 39515 and 38785. This setup presents a classic breakout opportunity, with price poised to either break above the upper boundary or fall below the bottom one. Traders should remain vigilant, as a breakout could lead to a market movement in either direction.
2. Contract Specifications: Nikkei Futures vs. Micro Nikkei Futures
Nikkei Futures (NIY1!) are a valuable tool for traders seeking exposure to Japan’s economy. The contract size is tied to the Nikkei 225 index, with each tick movement having substantial financial implications for the trader. Here’s a breakdown of the key specifications:
o Nikkei Futures (NIY1!):
Tick Size: 5 points.
Tick Value: 2,500 JPY per tick.
Margin: 1,500,000 JPY (varies as market conditions change)
Starting October 28, 2024, CME Group will introduce Micro Nikkei Futures, which will provide a more accessible option for retail traders by offering a smaller contract size and lower margin requirements. The Micro Nikkei contracts will allow traders to take advantage of the same market exposure with greater flexibility and reduced capital risk:
o Micro Nikkei Futures:
Tick Size: 5 points.
Tick Value: 250 JPY per tick.
Margin: 150,000 JPY (varies as market conditions change)
This introduction opens up new opportunities for traders looking to manage risk more effectively or for those who prefer to trade with smaller position sizes.
3. Breakout Trade Setup for Nikkei Futures
Currently, Nikkei Futures are stuck in a range-bound market, oscillating between 39515 and 38785. A potential breakout beyond these levels is potentially imminent, and traders can prepare to capture the momentum once it occurs.
The key to this setup is patience: wait for the price to either break above or fall below before entering any trades. Here’s the breakout strategy we’ll be focusing on:
Breakout to the Upside: Enter a buy trade if price breaks above 39515.
Breakout to the Downside: Enter a sell trade if price falls below 38785.
By leveraging this breakout strategy, traders can capture the volatility that usually follows a breakout from a tightly held range.
4. Breakout to the Upside: Trade Idea
In the event of an upside breakout, we anticipate that the price will rally after breaking through the 39515 level. Here’s the breakdown for this trade setup:
Entry: Buy at 39515, the upper boundary of the current range.
Target: The target is set at 40285, where there is a significant UFO resistance and a technical resistance level. This level marks a strong area where sellers may come in, making it a logical point to exit the trade and secure profits.
Stop Loss: To manage risk, place the stop loss a third of the profit zone below the entry price. In this case, the stop would be at 39258, minimizing downside exposure while allowing the trade to develop.
o Risk/Reward Calculation:
Profit zone: 40285 - 39515 = 770 points.
Risk (1/3 of the profit zone): 770 / 3 = 257 points.
Stop loss: 39515 - 257 = 39258.
For standard Nikkei Futures, each point is worth 500 JPY, so:
Potential profit: 770 points × 500 JPY = 385,000 JPY (approx. USD 2,580).
Risk: 257 points × 500 JPY = 128,500 JPY (approx. USD 860).
For the Micro Nikkei Futures, everything would be reduced x10 (approx. USD 258 and USD 86).
5. Breakout to the Downside: Trade Idea
In the case of a downside breakout, we expect a decline once the 38785 level is breached. Here’s how the trade setup would work:
Entry: Sell at 38785, the lower boundary of the current range.
Target: Set the target at 37920, a level supported by a UFO support, a technical support, and two nested Fibonacci retracement levels (23.6% and 61.8%).
Stop Loss: The stop loss is set at a third of the profit zone above the entry price. This protects against excessive losses if the market moves against the trade. The stop would be at 39073.
For standard Nikkei Futures:
Potential profit: 865 points × 500 JPY = 432,500 JPY (approx. USD 2,910).
Risk: 288 points × 500 JPY = 144,000 JPY (approx. USD 970).
For the Micro Nikkei Futures, everything would be reduced x10 (approx. USD 291 and USD 97).
6. Risk Management
Effective risk management is key to long-term success in trading. In both breakout scenarios, the use of stop-loss orders ensures that traders can limit their losses if the market moves against them. Additionally, setting precise entry and exit points reduces the likelihood of emotional decision-making, allowing for more disciplined trading.
The upcoming launch of Micro Nikkei Futures offers traders enhanced control over their position sizing and risk exposure. With smaller contracts, traders can engage in these setups with a fraction of the capital required for standard futures contracts. This flexibility is particularly beneficial for retail traders looking to manage risk effectively while still capitalizing on market opportunities.
Whether you are a seasoned futures trader or new to the Nikkei market, these breakout setups provide a solid foundation for capturing momentum. As always, risk management should remain at the forefront of your strategy, ensuring you protect your capital while pursuing profits.
When charting futures, the data provided could be delayed. Traders working with the ticker symbols discussed in this idea may prefer to use CME Group real-time data plan on TradingView: www.tradingview.com - This consideration is particularly important for shorter-term traders, whereas it may be less critical for those focused on longer-term trading strategies.
General Disclaimer:
The trade ideas presented herein are solely for illustrative purposes forming a part of a case study intended to demonstrate key principles in risk management within the context of the specific market scenarios discussed. These ideas are not to be interpreted as investment recommendations or financial advice. They do not endorse or promote any specific trading strategies, financial products, or services. The information provided is based on data believed to be reliable; however, its accuracy or completeness cannot be guaranteed. Trading in financial markets involves risks, including the potential loss of principal. Each individual should conduct their own research and consult with professional financial advisors before making any investment decisions. The author or publisher of this content bears no responsibility for any actions taken based on the information provided or for any resultant financial or other losses.
Microfutures
From Tokyo with Love: Key Opportunities with Japan's Top Index1. Introduction
The Nikkei 225 is Japan's premier stock market index and one of the most widely followed indexes in the world. As the representative of Japan's economy, the Nikkei 225 includes many of the country’s most influential companies across various industries, such as Toyota, Sony, and SoftBank. With Japan being the third-largest economy globally, traders who seek exposure to the Asian market find the Nikkei 225 to be a crucial addition to their portfolios.
Now is an opportune time to study and potentially add the Nikkei 225 to your watchlist, as Micro contracts are set to launch later this year, offering greater accessibility to both institutional and retail traders. These micro contracts will allow traders to manage their positions with more precision, capital efficiency, and reduced exposure. With the futures contracts denominated in both US Dollars and Japanese Yen, traders can select their currency exposure based on market preferences.
Contract Specifications:
# Nikkei/USD Futures:
Contract size: $5 USD per index point
Tick size: 5 points = $25 USD per contract
Margin: USD $12,000 per contract at the time of producing this article
Trading hours: Almost 24-hour trading, covering Asian, European, and US sessions
# Nikkei/YEN Futures:
Contract size: ¥500 per index point
Tick size: 5 points = ¥2,500 per contract
Margin: JPY ¥1,200,000 per contract at the time of producing this article
Trading hours: Mirrors the USD futures trading hours for global reach
For traders looking for exposure to Japan’s economy, these contracts offer versatile trading opportunities with sufficient liquidity, price movement, and round-the-clock accessibility. You can access real-time data on these contracts through TradingView - view the data package at www.tradingview.com
2. Global Market Diversification
The Nikkei 225 Index offers more than just exposure to the Japanese market; it’s a portal into Asia’s largest and most developed economy. With Japan being an export-driven economy, exposure to the Nikkei 225 allows traders to capitalize on trends in global manufacturing, technology, and industrials.
Additionally, during periods of macroeconomic divergence—where the economic performance of regions like the US and Asia deviate—the Nikkei 225 can provide a non-correlated trading opportunity.
3. Correlation and Hedge Against US Equities
While Japan is a developed economy like the United States, its market dynamics differ substantially. The Nikkei 225 often shows a lower correlation with US equity markets, meaning that the index tends to react differently to global and local economic events compared to indices like the S&P 500.
This graph illustrates the rolling 30-day correlation between the Nikkei 225 and the S&P 500, highlighting the fluctuating relationship between the two indices and how they decouple at times, especially during periods of heightened market volatility.
4. Japanese Yen and US Dollar Denominated Contracts
One of the unique aspects of the Nikkei futures is the ability to trade the index in either US Dollars or Japanese Yen. This flexibility allows traders to choose the contract that best suits their currency exposure preferences, providing a powerful tool for those who also wish to hedge or capitalize on currency movements.
Nikkei/USD Futures: These contracts are settled in US dollars.
Nikkei/YEN Futures: Conversely, for traders who want to factor in currency risk, the Yen-denominated futures offer exposure not just to the Nikkei 225’s price movements but also to the Yen's fluctuations against the US dollar or other currencies.
As the introduction of Micro contracts approaches, this will add even more flexibility for traders, particularly retail traders who prefer smaller contract sizes and more precise risk management. These contracts will enable traders to adjust their positions with greater capital efficiency, allowing for a wider range of strategies—from short-term speculative trades to long-term hedging positions.
5. Monetary Policy Divergence
Japan's monetary policy, led by the Bank of Japan (BoJ), has been historically distinct from the policies of the US Federal Reserve and European Central Bank (ECB).
Understanding Japan's monetary policy divergence allows traders to better time their entry and exit points in the Nikkei 225, especially as the Bank of Japan navigates its unique approach to economic stimulus and potential shifts in strategy.
6. Sector Opportunities
The Nikkei 225 is heavily weighted towards key sectors that represent the backbone of Japan’s economy, offering traders exposure to industries that may be underrepresented in other global indices. Some of the most prominent sectors within the Nikkei 225 include:
Technology: Japan is a leader in technology and innovation, with major companies such as SoftBank and Sony leading the charge.
Automotive: Japan’s automotive sector is world-renowned, with giants like Toyota, Honda and Nissan among the top constituents of the index. As global trends shift toward electric vehicles and sustainable manufacturing, Japan’s automotive industry stands to benefit.
Manufacturing: As a global manufacturing powerhouse, Japan's output is closely tied to global demand.
The Nikkei futures provide traders with a way to express their views on these industries, capitalizing on global demand trends in high-tech products, automobiles, and industrial manufacturing.
7. Volatility Trading
One of the key attractions of the Nikkei 225 futures is the index's volatility, which is often higher than that of its Western counterparts, such as the S&P 500. Traders who thrive in volatile environments will find the Nikkei 225 particularly appealing, as it presents more frequent and larger price swings. This heightened volatility is especially noticeable during global economic shocks or shifts in local economic policy.
Additionally, since Japan's market opens several hours before European and US markets, traders can use the Nikkei 225 to capture early momentum shifts that may influence sentiment in Western markets as they open.
This graph highlights the elevated volatility of the Nikkei 225 compared to the S&P 500.
8. Japan’s Political and Economic Landscape
Japan has been taking proactive steps toward economic reform in recent years. With initiatives aimed at corporate governance improvements, stimulus packages, and structural reforms. Several factors make Japan's political and economic landscape appealing for traders:
Corporate governance reforms: Japan has been improving its corporate governance structure, making its market more attractive to both domestic and foreign investors.
Economic stimulus packages: These government-led initiatives have provided a tailwind for many sectors within the Nikkei 225.
Weakening Yen: Japan’s export-driven economy has benefited from a weaker Yen, which boosts the competitiveness of Japanese goods on the global stage.
The potential for long-term growth makes the Nikkei 225 an appealing market for those who follow macro-driven opportunities.
9. Geopolitical Events and Trade Dynamics
Japan remains one of the world’s largest exporters, and as such, the Nikkei 225 is heavily influenced by global trade relations, particularly with the US and China. Traders can use the Nikkei 225 to take positions based on their views of the global geopolitical landscape. For example:
US-China trade tensions: Japan, being a major exporter to both countries, finds itself deeply connected to global trade trends.
Global demand for Japanese exports: Changes in global trade agreements or tariff structures could either boost or harm the performance of these industries.
10. Liquidity
Liquidity remains an important consideration, as the S&P 500 contracts offer greater liquidity, but the growing interest in the Nikkei 225 has resulted in increased volumes in recent months. As Micro contracts are introduced, the liquidity of the Nikkei 225 is likely to improve, making it an even more attractive trading instrument for all types of traders.
This graph highlights the trading volumes for both Nikkei 225 and S&P 500 futures.
11. Cumulative Returns Comparison
When comparing cumulative returns over time, the Nikkei 225 has demonstrated significant growth. However, this growth has come with a higher level of volatility than the S&P 500.
The Nikkei 225's higher risk-reward profile makes it an attractive option for traders looking to capture short- to medium-term gains during periods of economic growth or policy shifts in Japan.
This graph shows the cumulative returns of the Nikkei 225 versus the S&P 500.
12. Price Range Opportunities
The average daily price range of the Nikkei 225 is another compelling factor for active traders. The Nikkei 225 frequently exhibits larger daily price movements than the S&P 500, especially during periods of high volatility. This makes it an ideal market for short-term traders looking to capitalize on intraday price swings.
The graph, where daily price ranges have been multiplied by their corresponding point values, demonstrates how the Nikkei 225 has exhibited wider price ranges.
13. Conclusion
The Nikkei futures offer a unique set of opportunities for traders looking to diversify their portfolios, capitalize on volatility, and gain exposure to Japan’s leading industries. It is a powerful tool for both short-term traders and those with longer-term macro views.
In addition, the forthcoming Micro contracts will make the Nikkei 225 accessible to a wider range of traders, allowing for more precise risk management and exposure adjustments.
Key takeaways for traders considering the Nikkei futures include:
Global diversification beyond US and European markets.
The ability to hedge against US equity volatility.
Opportunities in high-growth sectors such as technology and automotive.
The potential for higher volatility, offering both risk and reward.
Flexible contract options in both USD and Yen, allowing for currency risk management.
For traders looking to add a new dynamic instrument to their watchlist, the Nikkei/USD and the Nikkei/YEN futures are a potentially ideal candidate, combining diversification, volatility, and sectoral exposure into a powerful trading product.
When charting futures, the data provided could be delayed. Traders working with the ticker symbols discussed in this idea may prefer to use CME Group real-time data plan on TradingView: www.tradingview.com - This consideration is particularly important for shorter-term traders, whereas it may be less critical for those focused on longer-term trading strategies.
General Disclaimer:
The trade ideas presented herein are solely for illustrative purposes forming a part of a case study intended to demonstrate key principles in risk management within the context of the specific market scenarios discussed. These ideas are not to be interpreted as investment recommendations or financial advice. They do not endorse or promote any specific trading strategies, financial products, or services. The information provided is based on data believed to be reliable; however, its accuracy or completeness cannot be guaranteed. Trading in financial markets involves risks, including the potential loss of principal. Each individual should conduct their own research and consult with professional financial advisors before making any investment decisions. The author or publisher of this content bears no responsibility for any actions taken based on the information provided or for any resultant financial or other losses.
Interest Rates Trading and Hedging Through a New LensIntroduction
In the dynamic world of financial markets, Micro 10-Year Yield Futures stand out as a pivotal tool for traders and investors. These futures offer unique opportunities to navigate the complexities of interest rates, particularly in an environment influenced by key economic indicators. This article delves into how traders can leverage both fundamental economic data and a novel technical analysis approach to optimize their strategies in trading and hedging with these futures.
Fundamental Analysis Approach
Understanding CPI, PPI, and Unemployment Rate:
Consumer Price Index (CPI): This indicator measures the average change over time in the prices paid by consumers for a basket of goods and services. It's a critical gauge of inflation, directly impacting interest rates and, consequently, the yields on Treasury securities.
Producer Price Index (PPI): PPI tracks the average change over time in the selling prices received by domestic producers for their output. It's a leading indicator of consumer inflation when producers pass on higher costs to consumers.
Unemployment Rate: This key metric reflects the number of unemployed workers as a percentage of the labor force. It’s vital for assessing the health of the economy, influencing monetary policy and interest rates.
These indicators, notably their changes, provide crucial insights for active trading, particularly in hedging strategies with Micro 10-Year Yield Futures. For instance, a higher-than-expected CPI or PPI might signal rising inflation, prompting traders to anticipate rate hikes and adjust their positions accordingly.
How to incorporate Fundamental Analysis into the trade decision process?
When making trading decisions for Micro 10-Year Yield Futures, it's crucial to understand the impact of economic reports on interest rates:
Buying (Long) Position Rationale:
When CPI, PPI, and Employment Rate (opposite of unemployment) are all increasing (indicated by green color on the chart), it typically suggests an expanding economy and potential inflationary pressures.
In such scenarios, interest rates are likely to rise to manage inflation. Hence, buying 10-Year Yield Futures could become a strategic move, anticipating a potential uptick in yields.
Selling Existing Long Positions:
A decrease in any of these indicators (CPI, PPI, Employment Rate) signals a potential slowdown or less aggressive inflationary pressure.
Traders holding long positions might consider selling to lock in profits or prevent losses, anticipating a potential drop in yields.
Selling (Short) Position Rationale:
If these reports show a decreasing trend (indicated by red color on the chart), it suggests economic contraction or reduced inflationary pressure.
Lower interest rates are often introduced to stimulate economic growth in such conditions. Shorting 10-Year Yield Futures could be advantageous as it would benefit from a potential fall in yields.
Buying Existing Short Positions:
An increase in any of these indicators (CPI, PPI, Employment Rate) signals a potential expanding economy and potential inflationary pressures.
Traders holding short positions might consider buying to lock in profits or prevent losses, anticipating a potential rise in yields.
Rationale Behind the Rules:
These rules are based on the traditional economic relationship between inflation, economic activity, and interest rates.
Rising inflation or strong economic growth (indicated by higher CPI, PPI, and Employment Rates) often leads to higher interest rates to prevent the economy from overheating.
Conversely, decreasing indicators suggest an economy that might need stimulation, often leading to lower interest rates.
By aligning trading strategies with these fundamental economic principles, traders can make more informed decisions, leveraging economic trends to speculate or hedge effectively.
Technical Analysis Approach
Yield Extremes and Curve Analysis:
This approach involves charting and combining the 2-Year and 30-Year yield futures contracts in one chart.
Analyzing the relationship between these yields provides insights similar to traditional yield curve analysis in a much more accessible format.
Key Indicator: A crossover between the 2-Year and 30-Year rates signifies a substantial shift in market sentiment and economic outlook.
How to Incorporate Technical Analysis into the Trade Decision Process?
As said, the crossover of yield rates between the 2-year and the 30-year yields is a pivotal event, suggesting significant changes in the yield curve. Here's how to interpret and act on these occurrences:
Identifying the Crossover Event:
A crossover event occurs when the 2-year yield rate overtakes the 30-year rate, or vice versa.
This event is indicative of a significant change in the interest rate environment, reflecting shifts in economic expectations and monetary policy.
Trading Strategy Based on Micro 10-Year Prior Price Action:
When the crossover occurs, the immediate strategy depends on the recent trend in the Micro 10-Year Yield Futures prices.
If the Micro 10-Year Yield was trending upwards prior to the crossover, it suggests bullish sentiment in the shorter term. In this scenario, traders could consider taking a short position, anticipating a potential reversal or bearish shift in the market.
Conversely, if the Micro 10-Year Yield was trending downwards, indicating bearish sentiment, traders could consider a long position post-crossover, capitalizing on the potential for a bullish reversal or recovery in prices.
Rationale Behind the Trade Rules:
The crossover event between the 2-Year and 30-Year yields represents a pivotal shift in market dynamics, often reflecting changes in economic policy, inflation expectations, or investor sentiment.
Prior price action in the Micro 10-Year Yield Futures provides a context for these shifts, indicating the market's prevailing trend and sentiment.
By aligning trading actions with both the yield curve dynamics (crossover event) and the recent trend of the Micro 10-Year Futures, traders can make informed decisions, leveraging the market's anticipated reaction to these significant economic indicators.
Market Outlook and Trade Plan
Keeping in mind the below tick and (Average True Range) ATR values, based on our analysis, we could express our market views through the following hypothetical set-ups:
Trade Plan for the Fundamental Analysis Approach:
ENTRY: Wait for the next CPI, PPI and Employment Rate reports and consider executing a trade if all 3 reports are either positive (long) or negative (short).
STOP LOSS: Located 1 Monthly ATR away from the entry price
Trade Plan for the Technical Analysis Approach:
ENTRY: The crossover may confirm itself at the end of the day. Wait for such confirmation and consider executing a short trade once confirmed.
STOP LOSS: Located 1 Monthly ATR away from the entry price
Tick Value: 0.001 Index points (1/10th basis point per annum) = $1.00
Monthly ATR: The average volatility is measured as 0.509 at the time of this report
Trade Example: If the 2-Year yield rises above the 30-Year yield amid rising CPI, consider a short position anticipating rate hikes.
Reward-to-Risk Ratio: Calculate this ratio to ensure a balanced approach to potential gains versus losses.
Risk Management in Futures Trading
Effective risk management is paramount. Utilize stop-loss orders and consider hedging techniques to mitigate potential losses. Understand the significance of economic reports and yield curve shifts in making informed decisions.
Conclusion
Micro 10-Year Yield Futures offer a versatile platform for interest rate trading and hedging. By combining monthly economic updates with a unique yield curve analysis approach, traders can navigate these markets with greater confidence and strategic foresight.
When charting futures, the data provided could be delayed. Traders working with the ticker symbols discussed in this idea may prefer to use CME Group real-time data plan on TradingView: www.tradingview.com This consideration is particularly important for shorter-term traders, whereas it may be less critical for those focused on longer-term trading strategies.
Disclaimer: The trade ideas presented herein are solely for illustrative purposes forming a part of a case study intended to demonstrate key principles in risk management within the context of the specific market scenarios discussed. These ideas are not to be interpreted as investment recommendations or financial advice. They do not endorse or promote any specific trading strategies, financial products, or services. The information provided is based on data believed to be reliable; however, its accuracy or completeness cannot be guaranteed. Trading in financial markets involves risks, including the potential loss of principal. Each individual should conduct their own research and consult with professional financial advisors before making any investment decisions. The author or publisher of this content bears no responsibility for any actions taken based on the information provided or for any resultant financial or other losses.
Euro to propel on relapsing EU inflation & US jobs dataFighting inflation is hard. Hence, central banks are data dependent while calibrating rates. Continuing geopolitical conflicts puts Europe at risk of inflation relapse.
Headline numbers can be misleading. Central bankers will dig deep. Deeper analysis will compel investors and policy makers to rethink and recalibrate interest rate calculus.
This paper unpacks US jobs & Euro area inflation report, and market expectations of rates ahead.
UNPACKING US NON-FARM PAYROLL DATA
The US labour market added 216k jobs in December 2023 surpassing expectations. It was up 25% month-on-month.
Headline numbers look healthy. Details spell trouble. Payroll data was revised lower by 71k for October and November. Average work week contracted, and participation rate declined.
Jobs growth is concentrated in three sectors, namely, Government, Education/healthcare, and Leisure/Hospitality. Eighty percent of the jobs added are from sectors that are not considered growth engines.
Three key takeaways from jobs report:
1. Employment growth remains robust: Month-on-Month employment trends point to jobs growth in government, leisure and hospitality, health care, social assistance, and construction, while transportation and warehousing lost jobs.
On a 12-month seasonally adjusted basis, apart from (a) Transportation & Warehousing and (b) Information, rest of the sectors added jobs.
Source: BLS
2. Hourly Wage Earnings growth is strong: In December, average hourly earnings on private payrolls jumped by fifteen cents, or 0.4%, to USD 34.27/hour. Average hourly earnings have increased by 4.1% over the last year.
Source: BLS
3. Unemployment Remains Unchanged: Unemployment rate was unchanged at 3.7% (3.5% last year this time) with number of unemployed persons unchanged at 6.3 million (5.7 million last year this time).
COMPREHENDING EUROZONE INFLATION NUMBERS
Euro area inflation rose 2.9% YoY in December 2023, reversing a two-year low (2.4%) observed in November. Eurostat inflation estimates was marginally below the market consensus of 3%. Inflation uptick since April 2023 was primarily due to energy-related base effects.
Energy prices declined 6.7% while services inflation was flat. Core inflation, excluding food and energy prices, softened to 3.4%. Core inflation is at its lowest point since March 2022.
MARKET EXPECTATIONS OF RATE CUTS
Investors are betting that the US Fed and the ECB will cut rates six times this year. First rate cut is expected in March or April.
Market expectations are in sharp contrast to policymakers. The US Fed expects to make three quarter-point cuts this year. The ECB has stood its ground arguing that the inflation fight is not over yet.
Amid strong economic data, probability of Fed rate cuts in March has fallen from 100% to 70%.
Source: CME Fedwatch Tool
EUR-USD WITNESSED WILD MOVES ON INFLATION, JOBS, AND SERVICES DATA BUT SETTLED WHERE IT OPENED
Last Friday news flow impacting FX rates were strong. Front month EUR-USD futures traded wildly opening at 1.0977 reaching a high of 1.1030 and then plunging to a low of 1.0908 before closing at 1.0977.
December US ISM Services PMI unexpectedly fell to 50.6, the lowest reading in seven months, compared to 52.7 in November. Services industry is critical accounting for more than two-thirds of the US economy.
Euro fell 0.5% last week, marking its largest weekly drop since early December breaking three consecutive weeks of strengthening.
The EUR-USD is hovering at its support levels with the 50d DMA likely to print a golden cross with the 200d DMA.
Near term technical signals point to strengthening of the Euro versus the US dollar. Momentum favours Euro while price reversion risk remains neutral.
Diverging macroeconomic conditions leaves Eurozone exposed to higher risk of inflation relapse. The ECB is expected to be slower with rate cuts relative to the Fed. In anticipation, leveraged funds are starting to sharply reduce their net short positions in the CME EUR/USD futures.
Source: CME QuikStrike
HYPOTHETICAL TRADE SETUP
Europe is at greater risk of inflation relapse on continuing geopolitical risks in Russia-Ukraine and the middle east. Energy and goods inflation relapse will force the ECB to defer its rate cuts.
Size of the rate cuts, if any, is also likely to be smaller at the ECB relative to the Fed. This will strengthen the Euro against the USD in the near term.
To harvest gains from a strengthening Euro, this paper posits a hypothetical long position in CME Micro EUR/USD Futures expiring in March 2024 (M6EH2024) with an entry at 1.0979 combined with a target at 1.1123 and hedged by a stop at 1.0871, delivering an expected reward-to-risk ratio of 1.33x.
Each lot of CME Micro Euro Futures contract provides exposure to 12,500 Euros. It is quoted in USD per Euro increment. Each pip i.e., 0.0001 per Euro delivers a P&L of USD 1.25.
• Entry: 1.0979
• Target: 1.1123
• Stop: 1.0871
• Profit at Target (hypothetical): USD 180 (= 0.0144; 144 pips; 144 x 1.25 = 180)
• Loss at Stop (hypothetical): USD 135 (= -0.0108; -108 pips; -108 x 1.25 = -135)
• Reward-to-Risk (hypothetical): 1.33x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Harnessing Gains from Yield Curve NormalisationNot too long ago, watching interest rates was as boring as looking at wet paint dry. Not anymore. Interest rates and currencies are as interesting as they get. The US dollar has been clocking moves more akin to an EM currency.
The greenback has been on a rollercoaster ride over the past three months in line with market expectations of Fed’s interest rate policy path. This paper is set in three parts. First, the background to rising rates and spiking yields leads to a brutal bond sell off. Then, the paper evaluates the case for further Fed rate hikes. In the third and final part, it dwells into factors that support a rate pause.
It is not just the rates but also the term structure of rates that’s gone off-the-chart. This paper posits a hypothetical spread trade inspired by the divergence in 30Y and 10Y treasuries with an entry at 13 bps and a target at 40 bps hedged by a stop at 5 bps delivering a reward-to-risk of 1.5x.
RISING RATES AND SPIKING YIELDS
Fed’s commitment to taming inflation with a higher-for-longer stance leads to a surging dollar. Spiking bond yields help reign in inflation through tightening monetary conditions.
The US 10Y Treasury Bond Yields surged to their highest level since 2007, by 20% or 0.8 percentage points since July 17th.
Chart 1: US 10Y and US 2Y Treasury Yields
Yield and Bond prices are inversely related. Surging yields have hammered bond prices lower resulting in a staggering record sell-off. Leveraged funds hold a record net short positioning in US 2-year and 10-year Treasury Futures.
Chart 2: Record Net Short Positioning by Leverage Funds
This brutal selloff has pushed yields to their highest levels in more than 15 years. Among others, portfolio managers and traders can position themselves one of the two ways:
Risk Hedged Yield Harvesting: Harvest risk hedged treasury yield using cash treasury positions and Treasury futures to generate income over a long horizon, or,
Gain from Yield Curve Normalisation: Deploy CME Micro Treasury Futures to engineer a spread trade to realise gains from a normalising yield curve.
In a previous paper , Mint Finance illustrated the first. Distinctly, this paper covers spread trade using CME Micro Treasury Futures.
THE CASE FOR HIKING
The September FOMC meeting re-affirmed a higher-for-longer rate regime. Though there was no rate hike, the updated Fed’s dot plot signalled very different expectations for the rates ahead.
The dot plot was updated to show a final rate hike in 2023 and fewer rate cuts in 2024.
Chart 3: Contrasting US Fed’s Dot Plot between 14/June versus 20/September ( Federal Reserve )
The Fed has adequate grounds to crank up rates even more as highlighted in a previous paper . These include (a) American exceptionalism where the US Economy has been remarkably resilient, (b) Expensive Oil due to geopolitics & receding base level effects, and (c) Brutal Lessons from past on the folly of premature easing.
THE CASE FOR PAUSE
Factors described above have led markets to price another rate hike at Fed meetings later this year. Those views have started to tilt further towards a pause since the start of October as per CME FedWatch tool.
Chart 4: Target Rate Probabilities For 13/Dec Fed Meeting ( CME FedWatch Tool )
Bond yields have surged, helping the Fed with their fight against inflation. Yields on US Treasuries surged to their highest since 2007. As yields are inversely proportional to bond prices, this is the equivalent of a major selloff in the bond market.
Three reasons behind the selloff:
1. Steepening Yield Curve:
Yields are finally catching up to market rates, especially for long-term treasuries; yield curve is steepening
Chart 5: Yield Curve is Steepening
2. Rising Sovereign Risk Premia: The US national debt passed USD 33 trillion and is set to reach USD 52 trillion within the next 10 years. Investors are demanding higher risk premia as compensation for default risk by a heavy borrower.
Chart 6: US Debt to GDP Ratio
3. Higher Yield to Compensate for Scorching Inflation: Investors are demanding higher real rates amid a high-inflation environment.
Chart 7: Real Yields are marginally above zero
Bond yields seem to be peaking. Solita Marcelli of UBS Global Wealth Management opines that the recent upward momentum in yields has been spurred largely by technical factors and is likely to be reversed given the overhang of uncertainty over underlying forces guiding the Treasury market.
Higher bond yields support a case for a Fed pause. This is because rising treasury yields do part of the Fed’s job. Higher treasury yields tighten financial conditions in addition to being a drag on the economy.
The Fed officials shared similar sentiments over the past week:
San Francisco Fed President Daly noted the moves in markets “could be equivalent to another rate hike”.
The Atlanta Fed chief opined that he doesn’t see the need for any more rate hikes.
The Dallas Fed President remarked that such a surge in bond markets may mean less need for additional rate increases.
The Fed has made it amply clear many times that it is data dependent. The data about the economy is positive. And that is concerning. Jobs data last week, and a sticky CPI print raise concerns that the Fed’s hand might be forced to hike despite US inflation being low among G7.
Chart 8: US Inflation is among the lowest within G7s
HYPOTHETICAL TRADE SETUP
Are we witnessing peak rates? In anticipation of the peak, investors can use CME Micro Treasury Futures to harness gains in a margin efficient manner. Micro Treasury Futures are intuitive as they are quoted in yields and are fully cash settled. They are settled daily to BrokerTec US Treasury benchmarks for price integrity and consistency.
As highlighted in a previous paper , each basis point change in yield represents a USD 10 change in notional value across all tenors, making spread trading seamless.
Setting up a position on yield inversion between 2Y and 10Y Treasuries is exposed to significant downside risks from near-term rate uncertainty.
Instead, a prudent alternative is for investors to establish a spread with a short position in 10Y rates and a long position in 30Y rates. The 30Y treasury rates demand a higher term premium due to their longer maturity.
Presently, this premium is just 0.15%. In the past, this premium has reached as high as 1% during periods of monetary policy shifts with yield curve steepening.
Chart 9: US Treasury Inverted Spreads
Furthermore, downside on this spread is limited as the 30Y-10Y premium scarcely falls below 0% unlike the 10Y-2Y premium which has been in deep inversion for the past year. A long position in 30Y Treasury and a short position in 10Y Treasury with:
Entry: 0.130 (13 basis points)
Target: 0.4 (40 basis points)
Stop Loss: -0.05 (5 basis points)
Profit at Target: USD 270 (27 basis points x USD 10)
Loss at Stop: USD 180 (18 basis points x USD 10)
Reward to Risk: 1.5x
Chart 10: Hypothetical Spread (Long 30Y & Short 10Y) Trade Set Up
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Where is the Euro Headed?Despite unprecedented rate hikes up to 450 basis points over the last 12 months the Euro has lost ground to the US Dollar for the last nine straight weeks. As a result, the Eurozone interest rates are historical highs.
Currencies desire nothing more than higher rates. The Euro should have popped but instead it flopped after the ECB’s rate hiking decision last Thursday. That says something about the underlying economy and the expectations for interest rates ahead.
This note puts forth data backed arguments that macroeconomic fundamentals in Europe is visibly weak. In sharp contrast, the robust economic fundamentals in the US provide strong tailwinds to the US dollar.
Consequently, the Fed has great monetary manoeuvring space which will impose bearish pressure on the Euro. Having cranked up rates to a peak unseen before, the ECB’s hands are tied with little room for further hikes despite its hawkish tone.
This paper posits a short position in CME Micro EUR/USD Futures expiring in Dec 2023. To seize opportunity from a weakening Euro, a short position with an entry at 1.071 combined with a target at 1.035 and hedged by a stop at 1.1025 will deliver an expected reward-to-risk ratio of 1.14x.
MONETARY POLICY TRANSMISSION TAKES TIME
Over the last year, the ECB has increased interest rates, an unprecedented ten times to combat surging inflation. That is a full 450 basis points.
Yet inflation remains sticky and persistent. Why? One obvious reason is monetary policy transmission.
Monetary policy transmission is the process through which a Central Bank’s monetary decisions impact the economy and the price levels.
The mechanism is characterised by long, variable, and indefinite time lags. As a result, it is difficult to predict the precise timing of monetary policy actions on economy and inflation.
DATAPOINTS SIGNAL WEAKENING ECONOMY
Selected data from the minutes of the Monetary Policy Meeting of ECB Governing Council held in July points to growing weakness in Europe.
1. Yield Curve Inversion Deepening: Together with negative euro area data, the inversion has reignited recession concerns. For now, the Euro area’s equity & credit markets remain resilient, hoping for a soft landing.
2. Sharp Contraction in Euro Area: Euro Area Composite PMI has been declining since April 2023 and in July it has fallen below 50. The dynamics are consistent with a weak GDP performance for the second and third quarters of the year. Housing and business investments are estimated to have declined.
3. Shrinking Demand for Loans: The latest bank lending survey signals further tightening of credit standards and sharp drop in loan demand in Q2 across businesses and households.
The reported demand for loans among corporations had fallen to an all-time low since the start of the survey in 2003 and, for the first time, was lower than at the height of the global financial crisis.
4. Growth could stall due to over correction: Growth could slow far more sharply if effects of monetary policy were more forceful than expected, or if the world economy weakens dampening demand for euro area exports.
AFTER UNPRECEDENTED RATE HIKES, WHAT’S NEXT?
As evident from weakening signals cited above, the ECBs hands are tied. ECB President Lagarde has little option other than maintaining a hawkish tone to manage expectations.
When the ECB regroups again in December, the likelihood of rate hike is thin.
Hawkish pause? Maybe.
As Katie Martin writes in her weekly opinion piece for the Financial Times, “few truly believe the central bank really would raise rates further, especially while the region’s economy feels the strain from the tighter policy enacted so far and from the impact of weaker Chinese demand on German manufacturing.”
ECB’s euro area growth forecasts are on the decline. The central bank expects 0.7% growth for this year (down from 0.9% as previously estimated). For 2024, the ECB now forecasts 1% growth (compared to 1.5% growth projected previously).
Forecasting the future is hard. It is evident from a survey of economists (see chart below) conducted by Bloomberg earlier this month. The market expectations are for rates to stay flat at 4% for now with rate reductions from Q2 next year. When these expectations become consensus, Euro weakening will accelerate.
DOLLAR CONTINUED STRENGTH AGAINST THE EURO
The Euro has shed more than 5% against the greenback since mid-July. Shaky fundamentals and an elevated risk of recession have raised questions on ECB’s ability to continue hiking.
Contrast this against the conditions in the US. The US economy has been marvellously resilient and set to have one of its best years yet. This backdrop emboldens the US Fed to take on an aggressive monetary posture.
TRADE SET UP
Interest rates at record elevated levels combined with weakening economy and feeble prospects, collectively pushes recession risks higher in the eurozone. This will corner the ECB into a pause or even cause it to hint at rate cuts during the December meeting. As a result, the Euro will be pressured lower against the US dollar.
To ride on the opportunities from a weakening Euro, this paper posits a hypothetical short position in CME Micro EUR/USD Futures expiring in Dec 2023 (M6EZ2023) with an entry at 1.071 combined with a target at 1.035 and hedged by a stop at 1.1025, delivering an expected reward-to-risk ratio of 1.14x.
Each lot of CME Micro Euro Futures contract provides exposure to 12,500 Euros. It is quoted in USD per Euro increment. Each pip i.e., 0.0001 per Euro delivers a P&L of USD 1.25.
• Entry: 1.071
• Target: 1.035
• Stop: 1.1025
• Profit at Target (hypothetical): USD 450 ( = 0.036; 360 pips; 360 x 1.25 = 450)
• Loss at Stop (hypothetical): USD 393.75 ( = -0.0315; -315 pips; -315 x 1.25 = -393.75)
• Reward-to-Risk (hypothetical): 1.14x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
Seeking Shelter from Recession in the Utilities SectorBoring is better in a recession. Fed Chair reaffirmed his steely resolve to fight inflation. In short, he wants to break the back of inflation "at any cost" to subdue it down to Fed’s target of 2%. Soft-landing is desired. But overcorrection to fend off sticky inflation could tip soft-landing into a hard one.
In a recession, economic activities shrink resulting in declining outputs and softening demand across consumers and businesses. Recession leads to rising unemployment and reduced consumer confidence.
History has ample evidence demonstrating that defensive sectors typically outperform the broad market index by more than 10% on average.
This paper posits a long position in Utilities Select Sector SPDR ETF ("XLU") to harvest potential outperformance gains plus a dividend yield of 3.3% and combined with a short position in CME Micro S&P 500 Index Futures.
INFLATION REMAINS HOT; FED RESOLVED TO FIGHT IT CAN LEAD TO RECESSION
Last week, Federal Reserve Chair Jerome Powell reaffirmed his determination to tame inflation down to its target 2%. He reasserted his singular focus on restoring price stability in the US. If that requires higher interest rates for longer to get back to 2% target, then so be it. That was the key takeaway from Jackson Hole Central Bankers Symposium in Wyoming.
US inflation is much cooler than a year before. History has taught policymakers an expensive lesson to avoid declaring victory too soon.
Softening inflation combined with record low unemployment, strong business climate and resilient consumer balance sheets point to a potential soft-landing. However, over correction could tip into a hard landing.
WHAT HAPPENS IN A RECESION?
During a recession, non-cyclical sectors, like Consumer Staples, Utilities, and Health Care, have historically performed well. The fortunes of these sectors hinge on non-discretionary spending and hence less sensitive to economic fluctuations.
These defensive sectors have outperformed the broad market by more than 10% on average during six of seven past recessions.
Tech & Real Estate rank among the worst-performers. Dependant on discretionary expenditure, these sectors are the first to face the heat when businesses and consumers cut spending as incomes shrink.
UNPACKING THE S&P SELECT SECTOR UTILITIES INDEX
The Utilities Select Sector Index ("Utilities Index") is market-cap-weighted and tracks the performance of the largest thirty utility firms in the S&P 500. It aims to deliver exposure to firms from the electric & water utility, independent & renewable power producers, and gas utility industries.
The Utilities Sector includes firms that provide essential services such as electricity, natural gas, and water. These firms marshal stable cash flows and low debt levels. Consequently, the sector is described as a defensive play which performs well during economic downturns.
The Utilities Index was launched on 16th December 1998. Over the last decade, the index has delivered an average annual return of 5.5%. It exhibits lower risk with a volatility of 12.5%. It is popular among long term investors looking for a defensive investment vehicle.
As of August 2023, the Utilities Index reveals an aggregate price-to-cash flow ratio of 10.1x, price-to-earnings of 19x, and one-year forward price-to-earnings ratio of 17x.
Largest firm in the index weighs in with a market cap of USD 136.6 billion. The smallest firm has a market cap of USD 8.5 billion. Weighted average market cap of the index stands at USD 51.15 billion. Top ten constituents forming 59% of the Utilities Index as of 22nd August 2023 are:
• NextEra Energy (14.85%)
• Southern Company (8.03%)
• Duke Energy (7.5%)
• Sempra (4.88%)
• American Electric Power (4.40%)
• Dominion Energy (4.34%)
• Exelon Corporation (4.32%)
• Constellation Energy Corporation (3.75%)
• Xcel Energy Inc. (3.47%)
• Consolidated Edison Inc. (3.37%)
Twelve-month price targets for the top-10 in the Utilities Index looks compellingly strong except for Constellation Energy and Consolidated Edison. Mean 12-month price targets are on average 14% above the closing price as of August 25th.
Investors securing a long position in the index can expect to generate positive returns from capital gains in addition to a healthy dividend yield.
RESILIENCE OF UTILITIES SECTOR IN A RECESSION
Experts who have been calling recession have been stumped and humbled with the resilience demonstrated by corporations and consumers.
A recession may be round the corner. Or we are living through a rolling recession and rolling recovery which impact one sector at a time.
The chart below produced by State Street Research powerfully captures various sector performance across business cycles. If a recession is round the corner, then holding a long position in Utilities is an astute investor choice.
COMPREHENDING UTILITIES SELECT SECTOR SPDR ETF ("XLU")
XLU is a convenient low-cost option for investors to secure exposure to the U.S. utilities sector. It was launched in Dec 1998 and has a low expense ratio of 0.1% of AUM.
XLU's AUM stands at USD 14.39 billion. Over the last six months, XLU has had a net inflow of USD 150.2 million.
XLU has a 20-day volatility of 12% and a beta of 0.52x. It pays out an annual dividend of USD 2.10 amounting to an annual dividend yield of 3.31%.
TRADE SET UP
A sector's outperformance does not necessarily mean that it will appreciate during a recession. Since, equity prices generally decline during recessions, outperformance can also mean that the decline in defensive and non-cyclical sectors will be less severe than the decline in growth sectors.
Investors can use a spread position to benefit from sectoral outperformance even when equity prices decline. This is because the losses from the long leg will be offset by profits from the short leg which is likely to perform worse.
The proposed trade set up comprises of a long position in XLU and a short position in CME Micro E-Mini S&P 500 Index Futures expiring in December 2023 (MESZ2023).
The XLU ETF settled at USD 63.63 per share on August 25th.
Each lot of MESZ2023 provides a notional exposure of index value times USD 5. MESZ2023 settled at 4463 on August 25th delivering a notional value of USD 22,315.
• Entry: 0.0142
• Target: 0.0160
• Stop Loss: 0.0135
• Profit at Target: USD 5,347
• Loss at Stop: USD 2,200
• Reward/Risk: 2.43x
MARKET DATA
CME Real-time Market Data helps identify trading set-ups and express market views better. If you have futures in your trading portfolio, you can check out on CME Group data plans available that suit your trading needs www.tradingview.com
DISCLAIMER
This case study is for educational purposes only and does not constitute investment recommendations or advice. Nor are they used to promote any specific products, or services.
Trading or investment ideas cited here are for illustration only, as an integral part of a case study to demonstrate the fundamental concepts in risk management or trading under the market scenarios being discussed. Please read the FULL DISCLAIMER the link to which is provided in our profile description.
How I Use Anchored VWAP's To Trade Nasdaq FuturesRight now the Nasdaq is at a very important area on my charts. We just came off another failed attempt of regaining the 200 Day Moving Average and now we are back to the VWAP from the opening day of the year and the VWAP from the low of the year. Both VWAP's are trading right around 14,550. I think that VWAP's from the open of the year and the low of the year are one of the best tools to test the trend of a market. Since we just failed at the 200 day MA, but we are still a good distance from the lows of the year, these VWAP's are going to be my key pivots for the next move in Nasdaq. I also use my Indicator, Beacon (which is free and open source on TradingView) along with Bollinger Bands to show you in this quick video how I will be trading E-mini Nasdaq & Micro E-mini Nasdaq Futures and Options in the coming days.
Past performance is not indicative of future results. Derivates trading is not suitable for all investors.
Why the S&P500 Micro Futures is one of the best markets to trade Hey Traders so today I wanted to show you a great market to consider trading the S&P500 Micro Futures. I think it is one of the easiest markets to learn vs the Forex and others. It offers great leverage and really good risk vs reward. Of course futures are different from stocks, crypto and forex. The are considered high risk because of the volatility and leverage. But definitely I think they are a good asset class to consider adding to every traders portfolio with the right risk management. Plus this market is a great way to start capturing all the great gains that the stock market has had in the last 10 years. As long as the bull market continues I think this market will remain strong.
Enjoy!
Trade Well,
Clifford
My Futures Trading Intraday Chart Setup For Success! ENA lot of people have emailed us in asking for our Trading View Intraday chart setup and workspace so we wanted to post some ideas here to our Trading View Followers as well. We will be breaking down each individual indicators we use such as Weekly, Daily Levels, Initial Balances Zones, VWAP, Time Frames, Market Internals and Volume Profiles to have a confident edge in your trade setups.