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April 1, 2018

Smart money flow indicator – technical implication

Smart money flow indicator – technical implication

Before we start talking about dollar, stocks and Smart money flow indicator I would like to share with you a quick set-up for AUDUSD before RBA cash rate decision on Tuesday.

The reason to be bullish on AUDUSD is a lag of RBA policy comparing to its counterparts like ECB or Federal Reserves, what may cause money outflow from the Australia what is not good. The policymakers in Australia will be possibly forced to support AUD with hawkish comments after a long dovish period.


RBA cash rate decision set-up



The Balance sheet  – next big driver for Dollar?


Federal Reserve continues to deploy all its monetary tools, reducing balance sheet by $79B for the first half of the year since the move was adopted. But what does it actually mean for stock, bond markets and ultimately for US Dollar?

As at the beginning of April the aggregate level of all assets held by Federal Reserve slid below $4.4T dollars. In other words the balance sheet were reduced by 79M dollars since September of last year, although Federal Reserve hasn’t started to sell the assets yet, relying mostly on maturing debt as a mechanism for the reduction. This decision was also known as a halt of reinvestment policy program which consists in stopping to use revenues from matured debt to buy bonds again from the market, maintaining balance sheet at a constant level.

Recall that US central bank took a decision to unwind its balance sheet in September last year, implementing new measures in October. According to the plan the balance sheet would decline in first three months by $30B. Every three months the pace of reduction will increase by $10B, till the monthly volume reaches $50B. The policymakers expected to gain maximal speed of reduction (“cruise speed») in October 2018.

After the first monthly increment in January by $10B, a current pace of decline is $20B/month. The ultimately goal is to bring the size of the balance sheet to $2.2T or cut it twice from current level until the end of 2021 year.




Open market operations (OMO), along with the interest rate and required reserve ratio (RRR) are three major tools used by the Fed to control monetary policy. Currently the Federal Reserve is at the stage of policy tightening what implies interest rate hikes, decrease of purchases and then selloff of government bonds and other debt securities in order to squeeze money liquidity from the economy. Balance sheet clearance leads to increasing supply of bonds on the market pushing their price lower and lifting yield to maturity. The corollary of this is rising demand for US Dollar in the long term as money and debt market are inversely related. Money flow back and forth from the debt market, depending on the monetary policy and economic conditions. As the time goes on, Fed’s “liquidity cleaner» will take center stage in the greenback supply/demand analysis, while interest rate hikes will be losing importance, as rate differentials with other countries are important not the interest rates itself.

Liquidity controls could become the primary focus for central bank policymakers since after the decade of liquidity surplus sharp change to a deficit can takes it toll on unprepared markets.

On the technical side, there is an interesting pattern making strong contribution to the bullish case of the dollar.


Smart money are reluctant to buy the “big dip” of the US stock market, shows Smart money flow indicator


According to Smart money flow index indicator smart money has been slow to use recent correction of the stock market to add more stocks into their portfolio:



Smart money flow indicator



The basic premise of Smart money flow indicator is that «newbies open the market, smart money close it». Emotional and news-driven traders tend to response to important overnight data and news during the first 30 minutes after session opening, making adjustments to their portfolios. Since this type of traders known for overreaction and mistakes in trading, experienced investors usually stand pat at this time, evaluating market performance during the day and place orders in the last hour or 30 minutes of the trading day. Smart money flow indicator shows that market performance at the start of trading session are prone to give false signals for the interpretation of the sentiments of investors and its better to rely on data nearly session close.

Looking back at two final trading sessions of the last week we can see that the last hour accounts for the main part of stock markets drop. The implication of this is that smart money hold bet on the extension of downward course of the stock market.

In our view if the stock market maintains current levels the odds are skewed to the upside, but breaking weekly support line traders risk to send the market into bearish state. The uncertainty prompted for larger market swings – indices volatility rose to such level that markets can gain or erase 0.5-1% easily. Also VIX remains elevated at 19.76 comparing to the historical low of 10 points which was seen before the correction.

Now we move to discussion about the US Dollar.


American Dollar has been losing ground for about one and a half year. Where is the end of this trend?



(Thanks for comfortable place for charting!)


From the beginning of 2017 Dollar has erased almost 14% from its value, declining from 103.6 level to 88.50. Several attempts have been made to break 88.00 level which failed though, what shapes convincing argument that dollar fundamentals are strongly against of further slump. Nevertheless its early to say that solid support immediately leads to reversal trend as essential fundamental backup can disappear, like unmet expectations for fiscal stimulus or rekindled trade war concerns. On the other hand the world starts to feel the shortage of Dollar liquidity, which, as was mentioned above, induced by Fed’s restrictive measures. 10YR-2YR Treasury yields spread confirms this movement

Volatility stoked on the US stocks markets could eventually trigger massive outflow from the stocks what serve as an additional demand factor for the US currency. Money outflows from the US in search for better R/R means that US stock markets are less attractive but with the confirmed upside trend after the correction demand for Dollar will start to rise again. Further stock market selloff is an unwelcome outcome for Donald Trump which boasted with gains from the start of his presidency, that’s why escalating conflict with trading partners is clearly a losing strategy for him.

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