When I woke up this morning to trade the NY session and started catching up on the price action of the Forex, equities, and commodities markets I got that gut feeling that said, "don't take a trade, you'll lose". It's been awhile since I sat through an entire NY session without taking a single trade but I'm glad I listened because I probably would have lost on trades today as the markets were very disjointed, choppy, and erratic to kick off the third quarter. My hat's off to all those traders who did make a profit today...
I can't put my finger on one exact thing that caused the markets to become disjointed but it was more a combo of central bank, fundamental, and geo-political factors. The erratic price action really started last evening in the Asian session with Fed Yellen's strong anti-dollar rhetoric. On the prospect of the Fed leaving their interest rate near zero for the next several years, Yellen said:
"It is not outside the realm of possibility; we have a very serious recession, we have a 9.4% unemployment rate, and inflation possibly falling further below the Fed's preferred level; we should want to do more. If we were not at zero, we would be lowering the funds rate"
That kind of central bank rhetoric is about as anti-dollar as it gets and the almost immediate response from the market was to drive the euro higher against the dollar. The reason why market participants sent their money-flows into the euro is because the euro is still yielding a minimum of 75bps higher than the dollar and when compared to the pound sterling, the euro yields a better rate against the dollar, so the euro was one of the main beneficiaries of Yellen's anti-dollar comments.
From a fundamental standpoint, it was mostly a mixed bag of somewhat-bad and not-so-bad data... the data that the S&P 500 and Dow Jones enjoyed most was the ISM report and specifically the ISM Price Index. ISM Manufacturing is still well below the 50 level but as I looked at the various components it's easy to see what the markets got excited about. The production and employment components were both up by over 6% and best of all, the prices component was up by 6.5%.
Remember, higher prices are good for higher-risk, higher-yielding markets, it's what these markets need... any price related components in this type of data that are not deflationary is just another reason to buy. Whenever a piece of fundamental data that is connected to price inflation prints hot or better than expected I've seen a clear pattern for equities to rise and the dollar to fall and this pattern played out again today.
And finally from a geo-political standpoint, the dollar was hammered by more comments from China. At 1158 EST, just as London was closing, these comments from a Chinese finance minister hit the news wires: "China has asked the G8 Italy summit to discuss issue of new global reserve currency; China requests reserve currency debate at G8"
Within seconds of these anti-dollar comments hitting the wires the EUR/USD jumped up over 60-pips, took out stops at the 1.4200 level and then fell right back down to the point of lift-off after NY closed this afternoon. I'm not exactly sure why the Chinese are talking the dollar down but all I can think of is that they are strategizing way in the future and not so much in the past or present.
The argument that the Chinese shouldn't talk the dollar down no longer holds any water because they have shown a pattern of using verbal rhetoric to depreciate the dollar in recent months. I believe the Chinese are thinking ahead by about 10-years and whatever their ulterior economic and social agendas dictate for the future probably includes the dollar being dethroned as the world's reserve currency.
All in all, it was a weird start to Q3 and it will probably stay weird as the markets deal with a tag-team NFP/ECB event tomorrow morning and Friday's US bank holiday...
NFP and unemployment rate event:
I'm going to get this out of the way now -- do not trade NFP tomorrow. You saw how wild last month's NFP event was and I expect no different tomorrow. The best way to properly manage your risk is to sit on the sidelines, let the market do its thing, and either trade after the dust settles or wait until next week.
Last month's NFP printed way better than expected but I believe that number will be revised lower tomorrow. Last month's unemployment rate will not likely be revised lower but possibly revised higher. As far as the actual market forecasts are currently running, this is what the bank traders are forecasting:
Non-farm payrolls consensus range: -435K to -225K Unemployment rate consensus range: 9.7% to 9.5%
My NFP forecast: -378K to -414K My unemployment rate forecast: 9.7%
The ADP NFP report came in much worse than expected at -473K but I do not think tomorrow's government report will breach that level. What Wall St. and the higher-risk, higher-yielders want to see is an NFP print that comes in as it did last month because they are still looking for any news-driven reason to keep buying and to keep prices supported.
The thing to remember is, this employment data from the BLS is hardly reliable and purely manipulated. If the markets are looking for a reason to go up, they will find it within the data... if the profit-takers want a reason to square their books ahead of the holiday weekend, they will find a reason within the data... if big money movers want to push the dollar and USD Index lower, they will find a reason in the data...
ECB interest rate event:
As important as tomorrow's NFP even is, the ECB interest rate policy and Trichet press conference is even more important and should likely have greater affect over the value of the EUR/USD. Monetary policy always trumps a single fundamental event and you can be sure all eyes will be on Trichet at 0830 EST tomorrow morning and looking for any sign or signal to either sell or buy the euro against the dollar.
That's what tomorrow's event is really all about... what to do with the euro... the Eurozone's dismal fundamentals have kept the euro's gains somewhat capped against the dollar and it's been the ECB's verbal rhetoric along with the euro's correlation to equities and commodities which has kept it from breaking below the 1.3750 level. If Trichet and his ECB comrades decide they want to continue their pro-euro stance this should be made clear at the press conference. Conversely, if Trichet wants to help support a Eurozone recovery by depreciating the euro, like the Swiss are doing with the franc, he will talk it down tomorrow.
As far as the ECB interest rate is concerned I see no change and for rates to be held at 1.00%. Trichet said he's not dropping rates this month and I'm going on his word. Obviously if Trichet was playing games with the markets and does decide to drop rates this would be a shock and unexpected move and the euro would sell-off against the dollar.
Central bankers like Trichet and Bernanke have been fairly trustworthy trade indicators in recent weeks, they've been telling the markets exactly what they want their respective currencies to do. So, as you're watching Trichet's press conference tomorrow and you're looking for signs he wants the euro to stay supported, he will say things like:
ECB interest rates have reached their lowest levels
ECB interest rates may rise in the near-term
The ECB is more concerned with inflation and price stability compared to deflation
Deflation is not at all an issue in the Eurozone
ECB forecasts show an end to the growth contraction in Europe and signs of a growth recovery are present
European credit markets are stabilizing and money and credit is expanding
The European banking system is sound
The ECB will not monetize any sovereign or commercial debt beyond their already existing program
The ECB expects German exports to rebound in the near-term
The employment situation in Europe is improving
The worst of the financial crisis is over and recovery is right around the corner
If Trichet wants the euro to depreciate he will make comments like this:
ECB interest rates have not reached their lowest threshold and may come lower in the near-term
The ECB is open and ready to use more non-standard measures
The ECB will monetize more sovereign or commercial debt
The ECB is concerned with deflation/disinflation
Consumer and producer inflation rates are expected to remain negative in the near-term
The European banking system remains at risk
Eurozone growth will contract beyond what the ECB has estimated
Unemployment will continue rising
The consumer will remain weak for a longer period of time than anticipated
The points on those two lists are the main things Trichet would say to either appreciate or depreciate the euro tomorrow. I can't predict which Trichet we'll get but I'm leaning towards him making more comments that are supportive of the euro compared to negative comments. The biggest risks for the euro obviously would be an announcement of interest rates being lowered and or more debt being monetized.
Even if you do not trade the EUR/USD you will be well served to watch Trichet's press conference because it's a great learning lesson for how central bank monetary policy and geo-politics drive price action of currencies and how these guys use verbal rhetoric to manipulate the Forex market. You can watch the press conference here.
Manage your risk:
On a scale of 1-10 tomorrow's trading risk is an 11. I really encourage all retail FX traders to practice some patience and good money management by sitting on the sidelines. I usually trade every NFP and ECB event but at this point I'm leaning towards sitting on the sidelines as well. The other risk factor beside these fundamental events is the fact the markets are severely ill-liquid right now. That means it takes far less money to move the market as opposed to what it may take under normal trading conditions when the level of market participation is higher.
The price swings could be very sharp tomorrow and not something you want to find yourself on the wrong side of... you could be on the right side of a market move and 30-seconds later find yourself on the wrong side of a price swing... that's the potential risk for tomorrow. If you can't help yourself from trading I suggest using at least half of your normal entry size. I always recommend for traders to use just half of one percent used margin entries so you may want to cut that in half for tomorrow and Friday.
Finally, a great Jesse Livermore quote to consider:
"After spending many years in Wall Street and after making and losing millions of dollars I want to tell you this: It never was my thinking that made the big money for me. It always was my sitting"
Markets show continued vulnerabilities to weak fundamentals:
Besides a healthy round of Q2 profit-taking which occurred across the board today, crude, gold, the S&P 500, Dow, EUR/USD and GBP/USD all came under pressure after astring of poorer than expected fundamentals caused market participants to scale back their risk appetites, sending their money-flows out of the higher-risk, higher-yielding markets and back into the safe havens of the USD, JPY, and Treasuries.
Higher-yielders like the euro and pound sterling made their highs, topped out and began reversing lower after the markets were hit with several downside surprises on both UK and Eurozone data. The pound sterling was especially hit hard and sold-off strongly after the latest UK Final GDP data was released and digested.
Once Wall St. got rolling equities were actually in the green but within seconds of the Consumer Confidence data hitting the news wires, the Dow, S&P 500, crude, and gold did a complete reversal, dragging the EUR/USD and GBP/USD with it. I think what was most interesting about today was how the markets showed their sensitivities to fundamental data and how fundamentals connected to growth and the consumer continue to drive overall market sentiment, risk appetites and money-flows... before all the big data came out this morning the markets ran up all the higher-yielders only to bring them all back down as the bad data erased the euphoria and brought back a sense of fear.
In recent weeks the trend with the fundamentals have been for better than expected numbers and this has been very supportive of prices but now we are starting to see signs that the markets haven't fully embraced risk because on days like today when the data surprises to the downside the markets sell-off.
Q2 market review -- how the EUR/USD and its correlated markets performed:
Overall, the second quarter was good for the S&P 500, good for crude, good for the EUR, GBP, and AUD and bad for the USD and JPY. During Q2 crude oil, equities and the higher-yielders like the EUR/USD and GBP/USD made their year-to-date highs while the USD, US dollar Index, and Treasuries hit their lows. Obviously this isn't a coincidence based on how those markets correlate with each other but what should be noted is that the strong upside momentum seen during the height of the euphoria on Wall St. has clearly subsided as we now enter Q3 and full on summer trading conditions.
We'll get to Q3 in a moment but lets first take a look at how the correlated markets performed during Q2... S&P 500 vs. US dollar Index--
The two "gods of war" did battle all quarter long and the S&P 500 clearly emerged as the winner here as the S&P 500 gained 15% in Q2. At the start of the quarter the S&P 500 was trading around the 780 level running all the way up to the 950 level on 11-June. The US dollar Index started the second quarter right near its highs at the 86 level, made it a few ticks above 87 and then fell dramatically to the 78 level by 2-June. Just based on the numbers we see some pretty clear evidence the S&P 500 and USD Index maintained a fairly tight inverse correlation just as they should.
Crude oil--
In my opinion crude oil was the leader of the Q2 rally and the center of the financial universe. Spot crude started the month a few pennies above the $47 level and was only $15 above its year-to-date low back in Q1. After failing to sustain a break below the $43 level, on 21-April spot crude took off and never looked back the entire second quarter. On the very same day spot crude made its quarterly low, the S&P 500 made its quarterly low, rising from the 823 level and never returning that low the rest of the quarter. The very day and exact hour that spot crude hit its high above the $73 level the S&P 500 futures also hit its high above the 952 level. Coincidence? Of course not.
EUR/USD--
Any traders using the equities and commodities correlation to trade the EUR/USD, GBP/USD, GBP/JPY, and EUR/JPY should have had a relatively profitable second quarter because the correlations worked about as beautifully as it gets. Add in the fact the Fed told the markets to sell the dollar on two separate occasions made trading even easier. The first time the Fed told the markets to sell the dollar was just a few days before Q2 began... on 18-March the Fed gave their first "please sell the dollar" message to the markets and the markets did exactly as they were told. A few weeks later, in Q2, the Fed renewed its anti-dollar message in their FOMC meeting minutes.
So as Q2 began the markets were comfortably in an anti-dollar and pro-euro, pro-crude, pro-equities frame of mind based purely on Fed monetary policy. On 18-March when the Fed told the markets to devalue the dollar, the euro gained about 500-points on the dollar, a month later the euro made a test on the downside from where it took off on that day, it failed to break lower and then never looked back the rest of the quarter. The EUR/USD's bottom to top move during Q2 was from the 1.2880 level all the way up to the 1.4330 level.
Crude oil, the S&P 500, the Dow Jones, the EUR/USD, GBP/USD, GBP/JPY, and EUR/JPY all made their year-to-date highs during Q2 while the US dollar and US Treasuries hit their year-to-date lows but out of all those correlated markets, only crude oil has shown any ability to sustain its gains and make repeated upside attempts to break its yearly highs.
Q3:
Looking ahead at Q3 I see some potential trouble for the higher-risk, higher-yielders especially if they continue to show this recent pattern of being vulnerable to poor fundamentals. Remember, for the equity markets it takes sustained buying conviction to keep prices supported and moving up. That sustained buying conviction has obviously dried up in recent weeks and I think the only thing keeping Wall St. alive right now is crude's continued support above the $65 level.
As I say in many of my updates, I still think crude oil is the linchpin that makes or breaks the markets. The euro had a great quarter against the dollar but this is not because the euro is strong, or because its bullish, or because the Eurozone is in better shape than the US. All the evidence for why the euro made a strong Q2 run against the dollar is clear and if crude oil gives way to the downside it will bring the S&P 500 and the euro down with it.
Bear in mind what kind of efforts the ECB went to during Q2 to talk up the euro. Last week the ECB had six of their own central bankers talk the euro up about 300-points against the dollar and that was the pattern they followed all quarter long. Will the trend of the ECB talking the euro up continue in Q3? I have no idea but the euro's first Q3 test will happen on Thursday at Trichet's monetary policy press conference.
As a whole, the markets will get their first Q3 test with Thursday's NFP and Unemployment Rate event. Trying to predict or forecast what Q3 is going to be like isn't worth burning brain cells over but unless the correlated markets become completely disjointed I plan on trading the same exact way I've been. If China puts out some hot fundamentals during Q3 and crude oil can sustain a move over $75 this would obviously be supportive of the S&P 500 and the higher-yielders in the Forex market.
China was a pretty important fundamental factor in Q2 and as long as market participants rest their hope in a Chinese recovery, good or bad, the Chinese data should continue to drive money-flows. Also, the Fed and ECB played the see-saw game quite well during the last part of Q2 in order to keep the EUR/USD in a fairly tight range. It's not been in the interest of the Fed and ECB and their respective economies to see large daily fluctuations in the price of the EUR/USD and US dollar Index. So for Q3 I will closely monitoring every piece of rhetoric and monetary policy action by the Fed and ECB in order to see which currency they want stronger and which one they want weaker. Q3 monetary policy--
I see no change in the Fed Funds Rate during Q3, it won't go up and it won't go down. The ECB on the other hand does have room to cut rates in Q3. A few days ago Trichet said he's not cutting interest rates on Thursday but this doesn't mean he won't cut them in August or September. Fundamentally, the Eurozone is entering the third quarter in a deep recession. The European banking sector remains fractured, growth has strongly contracted, German exports are at multi-decade lows, some European sovereign debt has been downgraded and worst of all is the imminent threat of deflation.
Here again I can't predict how Trichet will handle ECB monetary policy this quarter but he's got his hands full because the fundamentals are not improving for Europe and the inflation/deflation situation is ugly. A persistently strong euro isn't doing the Eurozone any favors right now and I think if a strong euro becomes too painful and the ECB comes under pressure they could easily use monetary policy or verbal rhetoric to bring the euro lower, I'm not ruling this possibility out at all during Q3.
The other risk for the euro is that the ECB could embark on a loose monetary policy path of monetizing debt. The Maastricht Treaty prevents the ECB from doing exactly as the Fed and BOE are doing with their sovereign debt but these central bankers are creative enough to get around rules and regulations, when they have an agenda they can make it happen. Of course this is also a risk for the dollar should the Fed decide to buy more than $300 billion worth of Treasuries in Q3.
At some point during this quarter more talk of hyperinflation will emerge and that could make things interesting but I'm not forecasting any hyperinflation happening in Q3. Consumers are still punishing economies right now and they are causing more of a deflationary environment. When consumers embrace the old ways of relying on credit and debt, the price inflation will return but for now all this talk of hyperinflation is absurd. Last summer it cost me $3.25 for a gallon of milk and $4.10 for a gallon of gas. This weekend I paid $1.58 for that same gallon of milk and $2.35 for a gallon of gas. All the money the Fed is printing is purely inflationary but there is no hyperinflation, there is disinflation right now.
So for Q3 I believe we continue seeing mostly loose and sloppy monetary policy in order to reinflate the markets and keep prices supported.
Wednesday trading:
Trading tomorrow could get very interesting... its the first day of the new quarter and that usually means some market participants attempt to pre-position themselves for the next three months. In addition, we have another full load of fundamental data which I expect the markets to react to. The bulk of the key data comes out of the US with ADP NFP, ISM, Pending Home Sales, Construction Spending and Crude Oil Inventories. Your guess is as good as mine for how this data will print and even though ADP is about as worthless as it gets the markets may take a strong reaction to any upside/downside surprises on that data.
You remember what kind of intense volatility last month's NFP report brought to the markets... we could easily see a repeat performance on Thursday, so if ADP prints much better or worse than expected we could see the markets move strongly in anticipation of Thursday's employment event. The markets may also see more rounds of profit-taking ahead of the ECB, so be on the lookout for that.
Basically it's looking like we could have some heavier price swings tomorrow as the liquidity and market participation will be low and there will be plenty of numbers and data sets for market participants to jump on all day long. As far as trading goes, I still favor selling the dollar and yen against the majors and crosses into their strength (i.e. buying the dips). The EUR/USD went 1-pip below my last downside key level today and bounced nicely, so as long as the markets keep buying crude and the S&P 500 on the dips, I'll keep buying the EUR/USD when it dips. When I do see crude oil finally show viable signs its cracking and breaking down I'll feel more comfortable buying the dollar and yen against the majors and crosses but not until then.
All the currencies are crap but from a trading standpoint I'm not going to fight against the market correlations or what the central banks want... when they want the dollar higher and the euro lower I trust they will say the word, they've been reliable market-movers. As always, be very smart with your risk and money management. EUR/USD key levels will be posted before Wall St. opens tomorrow.
When I sat down to write my commentary on this week's trading all I could think was, "this should be a wild week". What's facing the markets are a number of calendar events and central bank events that are all culminating over the next five trading days, so thekey theme I want traders to keep in the forefront of their minds and trading decisions -- risk management. High risk alert--
Over the next 48-hours the price action of the Forex market, equities, commodities, and fixed income will all be under the direct influence of a major calendar event that I like to refer to as "end of quarter book squaring". Monday and Tuesday are the final two trade days of Q2 and that will be the very last opportunity for market participants like hedge funds, money managers, brokers, institutional traders, and participants in banking/finance to show some kind of a profit or to mitigate an unrealized loss.
Historical price action patterns and historical price behaviors show a repeated pattern of heightened volatility and extended periods of strong price swings the final 48-hours of each quarter. This is not a random coincidence but due to the process for how market participants close out positions, for profit or loss. The end of quarter price swings also repeatedly reoccur due to the continuous and varying degrees of money-flows and levels of liquidity that are moving in and out of all the financial markets as participants are squaring up, repositioning, or pre-positioning.
The strong correlation between currencies, crude oil, gold, the S&P 500, Dow Jones, and Treasuries dictates the high probability for intensified price action across the board as each of those individual markets affect each other as a whole. At least for the next 48-hours forget the charts, forget the multi-colored dissecting lines, all that junk is meaningless because the markets will be driven by fear and greed... just follow the money trail...
The end of quarter window dressing that goes on is driven purely by fear and greed -- fear that a money manager or hedge fund won't show a profit for Q2 or greed that a money manager or hedge fund can potentially show a bigger profit than expected in order to pad their fees and commissions. Many market participants are under intense pressure to show a profitable performance in order to make their quarterly statements look good and this means some of those participants will either take profit off the table, be forced to cover an unrealized loss, or to do some revenge trading to make that bonus or commission and to keep the phone calls from angry clients to a minimum.
I love the end of quarter madness because it shows how human emotions really control markets and drive price action. I recommend to most retail Forex traders to sit on the sidelines while the markets go through this process, especially for those traders who are too under capitalized to be in the FX market in the first place. End of quarter trade plan--
Other than reducing the amount of margin I use for each trade position I won't be doing a whole lot different over the next 48-hours in terms of how I pick my entries and exits. That being said, I am starting the week with an anti-dollar bias until we at least get through the end of quarter book squaring event. In my trading career I've been through ten end of quarter events and based on what my experience shows me and on what historical price action shows, the dollar historically has a higher probability of weakening against the euro.
With the Forex market's tendency to repeat price patterns over and over again, I'm choosing not to fight against history or human behavior. Of course if crude oil, gold, and the S&P 500 make gains over the next 48-hours the dollar should be under downside pressure just from those factors alone.
After we get past this calendar event I may reevaluate my anti-dollar bias because we will be coming up on the 1-year anniversary of the market's monumental meltdown. It was just two weeks into Q3 last year that the Forex, commodities, and equity markets plunged from their historical highs... the EUR/USD, crude oil, and the S&P 500 all made their historical highs in tandem (not a coincidence) and as crude oil was the first to crack and sell-off from the $147 level, the S&P 500 tanked which took the EUR/USD from the 1.6000 level all the way to the 1.2300 level between last July and October.
I'm not predicting or expecting an exact repeat performance of last summer but after we get past this week's calendar events which include an ECB monetary policy meeting and NFP, there's really no way to predict what the markets will decide to do next. History will always repeat itself but at this point I am not seeing the market's sentiment move closer to the side of risk aversion as opposed to where participants have been in terms of maintaining a higher risk appetite.
Keep things as simple as possible, don't fight against the market correlations even if they appear disjointed at times but to just go with the flow, follow the money and when you do not have a clear view on where you think the market will go, sit out and protect your capital. The great Jesse Livermore once said:
"The game of speculation is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, the person of inferior emotional balance, or the get-rich-quick adventurer. They will die poor."
Fundamental events moving markets this week:
The end of month/end of quarter/start of new quarter are not the only calender events that will move markets this week. There are a number of fundamental factors that will come into play as traders attempt to determine the short-term fate of the euro, dollar, pound sterling, and yen. Underlying fundamental factors like inflation, deflation, monetary policy, employment, manufacturing, and the health of the consumer will all come into view by the markets.
The following fundamental factors hold the highest potential to move the EUR/USD and its correlated markets this week:
Eurozone Consumer Confidence (Monday 0500 EST)
Eurozone M3 Money Supply (Tuesday 0400 EST)
Eurozone Flash CPI (Tuesday 0500 EST)
US Consumer Confidence (Tuesday 1000 EST)
German Retail Sales (Wednesday 0200 EST)
ISM Manufacturing and ISM Prices (Wednesday 1000 EST)
Pending Home Sales and Construction Spending (Wednesday 1000 EST)
Non-Farm Payrolls and Unemployment Rate (Thursday 830 EST)
Eurozone Retail Sales (Friday 0500 EST)
US bank holiday (Friday)
There will also be plenty of central bankers from the Fed, ECB, BOE, BOJ, and SNB speaking this week. The markets are still ripe for market-moving verbal manipulation, do not get caught off guard because the central bankers may want to use the market conditions to their advantage this week to move their respective currencies one direction or the other. The ECB and monetary policy:
At 0745 EST on Thursday the ECB will release their latest decision on their monetary policy for the key lending rate. At this point I see a no-change in their interest rate policy. The main reason I believe the ECB rate will leave rates at 1.00% is because Trichet has repeatedly said he's not cutting rates this month. Trichet could just be messing with the market's minds but his pattern of behavior in the past shows a much higher tendency for his rhetoric on interest rates to match actual monetary policy.
Remember what the ECB did to the dollar last Tuesday? In case you forget you can re-read it here. It only took a few comments on interest rates from the ECB to send the euro flying against the dollar last week. If Trichet wants to boost the euro again he can do it at his monetary policy press conference on Thursday.
For the past few weeks the Fed and ECB have worked well together to keep the EUR/USD in a relatively tight range. The purpose for this isn't anything I know but it doesn't matter, the evidence is clear based on all the verbal rhetoric and monetary policy actions by both central banks. The latest FOMC monetary policy event did not reveal a strong pro-dollar bias. I think their statement left the door open for market participants to continue selling the dollar when the opportunity presents itself.
The ECB has maintained a fairly consistent pro-euro stance recently. Could this change suddenly? Of course, but for now I'm adding the central bank and monetary policy factors as another reason for my anti-dollar bias because the recent trend between the Fed and ECB has been anti-dollar, pro-euro. Until the central banks change their bias, I'm not changing mine.
Trichet is pretty reliable when it comes to telling the market what to do with the euro. If Trichet wants the euro to keep gaining on the dollar he will paint a good picture of the Eurozone's economic, fundamental, and banking sectors. If Trichet tells the markets that deflation is not an issue and that ECB interest rates have reached their lowest threshold, that's his way of telling the markets to appreciate the euro and to buy it against the dollar.
If Trichet wants the euro to depreciate he will tell the market's the ECB is concerned about deflation, that interest rates can go lower in the future, that the ECB is going to monetize sovereign debt, that the Eurozone economy is going to contract further than previously expected, and that the European banking system is fractured.
I can't predict which message we will hear from Trichet but it won't be hard to figure out at his press conference. It should not be a mystery, Trichet uses less double-speak than Bernanke and it is very easy to read between the lines to decipher what he wants the market to do with the EUR/USD.
Treasury bonds and the US dollar:
The past couple of months there's been a lot of focus put on Treasuries and the US debt market, and ever since the Fed announced it would buy up to $300 billion worth of debt, the Treasury/Dollar connection has received the full attention of market participants. When I see something on Bloomberg or CNBC about Treasuries and the US dollar I never see the commentator or analyst explain the relationship between the two.
I think it is important for Forex traders to get a grasp on the Treasury/Dollar connection because their relationship affects both the debt and currency markets in very specific ways. The currency market is not a single entity unto itself and one of the correlated markets which helps determine currency valuations is the US debt market.
Next to the currency market, the US Treasury market is the most liquid in the world. This means the Treasury market can easily handle multi-billion dollar transactions, they can absorb selling pressures while preventing wild price swings, Treasuries are easily converted and there has never been a default on US debt, to date. US Treasuries are considered to be the safest and least riskiest asset class used for investment purposes.
One of the big reasons Treasuries have a strong affect on not just the Forex markets but all financial markets is because they are made up of the two biggest components that drive risk appetites -- price and yield (rate of return). All tradeable financial market are just a space for speculators to seek a rate of return on their money. Some speculators want to get that rate of return as safely as possible while others want that astronomical rate of return. But the way it works is, the lower the risk, the lower the yield, the higher the risk, the higher the yield.
In order for market participants to trade in the US Treasury market they need to use the US dollar and in order for the Treasury to meet its obligation to its creditors they need to use the US dollar. The use of the dollar comes full circle from the moment the investor hands the US government his money for a predetermined amount of time back to the moment when the federal government pays their creditor interest and then principle when the debt obligation comes to full maturity. That factor alone is just enough to affect the dollar's valuations against currencies like the euro, pound sterling, Swiss franc, and yen.
The other key factor which causes the valuation of the dollar to change is also directly related to the yield of each respective US debt obligation. Earlier this year the 10-year note was yielding just 6bps above the 2.00% level and now the 10-year is yielding over the 3.60% level. That means the US government is getting a lower price for their debt and that it will cost the government more money to pay its debts. Right now the US government has a major deficit problem, public debt has skyrocketed and those factors are bad for the US dollar and are a strike against it.
Then when the Treasury prints money to give to the Fed to return it back to the Treasury in exchange for its own debt, the dollar gets a really big strike against it. In a normal world this process of monetizing sovereign debt would be impossible but when you have the Fed and Treasury working so closely together with powers that are not even constitutional, they are like the Super Friends of the financial markets, they can just do whatever they want and nobody can stop them.
All Treasuries have a minimum denomination of $1000 and there will always be more supply than demand and that's another reason the Treasury market is so liquid and how multi-billions of dollars can move in and out of the market on a daily basis. This factor also has a direct affect on the valuation of the US dollar at any given moment of the trade day.
The other factor with the connection between Treasuries and the dollar is debt repayments... lets suppose you bought a $1000 debt obligation on the 10-year note at a yield of 4.00%. That means the government would pay you $20 every 6-months and then at the date of maturity they would return your $1000 in principle. The more debt that is supplied and purchased means the government has more debt to pay back which is bad for the dollar. Plus, the more debt that is supplied means the yield is higher and the government has to pay more to get less.
Dollars have to be printed to facilitate these processes and of course that is a big strike against the dollar. A market situation where Treasury yields are rising can be dollar positive but the cause for the higher yields is the key. If Treasury yields are rising because the Treasury is over supplying the market with debt, that is bad for Treasuries and bad for the dollar. Printing money is the purest form of inflation and when inflation rises the value of Treasuries falls.
Foreign debt holders like the Chinese see their investment in Treasuries erode when the value of their investment falls and the dollar weakens. Whenever inflationary price pressures pick up again in the future any foreign investment in Treasuries will devalue accordingly. Add the combination of inflationary price pressures and a depreciated US dollar and US debt looks pretty unattractive.
I don't want to over complicate this stuff but hopefully this sheds some light on why the Treasury market is so closely correlated to the Forex market and why movements in the Treasury market lead to movements on pairs like the EUR/USD, USD/CHF, GPB/USD, and USD/JPY. Even though I'm purely a currency trader I keep close tabs on the Treasury market because I think bond traders are very smart and well adjusted to the fundamental, monetary policy, and geo-political factors which move the markets. Swiss National Bank interventions:
Between March and as recent as last week, the SNB has gone on a quest to manipulate and devalue the Swiss franc. In the past three months there's been at least six open-market operations by the SNB and BIS to depreciate the franc versus the euro. The secondary affect of their open-market operations results in the dollar gaining against the franc and because the USD/CHF and EUR/USD maintain mostly an inverse correlation, the EUR/USD routinely moves lower during these interventions just for the fact the USD/CHF and EUR/CHF move higher.
Why the SNB is depreciating the franc--
The SNB and BIS are most concerned with the valuation of the EUR/CHF and their main objective is to sharply weaken the franc against the euro. The SNB's motivation to devalue their own currency is about as simple as it gets... debt holders in Europe, especially in Eastern Europe owe Swiss banks money and they want to get paid, bottomline. The Swiss are good financiers and so they are using monetary policy to make it easier for European debtors to pay their Swiss creditors. The secondary factor is to help support the Swiss exporting industry.
The SNB dumps francs and buys euros right on the open market and that's why those 150-point spikes occur on pairs like the EUR/CHF and USD/CHF. I do not trade either of those pairs but if I did I would be watching the SNB and BIS like a hawk and I'd never attempt to trade against them. Traders who are purely technical and who do not pay attention to the central banks have been steamrolled by these interventions and those traders who understand how the central banks affect the Forex market have been on the right side of these moves.
I personally think the interventions can continue in the near-term until the SNB has achieved its objectives. As long as Eastern Europe remains on the brink, the Swiss will likely see to it the CHF remains depreciated against the EUR. Do not fight the SNB on this stuff, it's not worth it. Central banks love using the element of surprise to hit the markets when they least expect it and this week could easily present more opportunities to see a repeat performance. Correlated markets:
Beside all the monetary policy, fundamental and calendar events that will be moving the markets we need to keep up with the price action of crude oil, gold, the S&P 500, Dow, and Treasuries. If the higher-risk, higher-yielding correlated markets make upside moves the dollar and USD Index will come under renewed selling pressure this week. Beside all the underlying fundamental factors, crude and gold will be the two linchpins which can make or break the markets and I will be watching both closely and using both as trade indicators.
Support and resistance levels--
In preparing for the trade week I spent some time studying the most recent price action and price behavior patterns of the markets and these are some of the overall key price levels on the upside and downside I'll be monitoring...
Spot crude -- the market has shown a pattern of buying crude when it dips below both the $69 and $67 levels. Below there is more support sitting around the $65 level. I'm not expecting any big downside moves with crude this week unless there are heavy rounds of profit-taking or geo-political factors that might come into play. On the upside strong resistance is seen just above the $73 level with minor resistance seen around the $72/$71 level.
Spot gold -- gold spent most of the month of June in a downward directional move but the same exact day the six ECB's came out to talk the euro up against the dollar, spot gold hit a bottom and has since moved up decisively (not a coincidence). Currently there is some resistance between the $943 and $945 levels while support is sitting at the $923 and $913 levels. Strong resistance for spot gold sits around $988 while strong support is currently around $888. A strong move up in gold this week should carry the euro and pound sterling up with it.
S&P 500 futures -- this correlated market has had a wild ride in recent weeks... the S&P 500 futures made three solid attempts to sustain a break of the 952 level on the topside and failed. On the downside, the market made several runs at the 888 level but also failed to break below there. Near-term support is sitting around 901-900 while near-term resistance is around the 920-925 levels. If the S&P 500 puts in a strong showing it should carry the higher-yielding currencies right along with it or vice versa.
EUR/USD -- price action patterns show the first line of support is strong at the 1.3982 level and then at the 1.3828 level, and then further strong support sits at the 1.3753 level. On the upside, there will be some resistance around 1.4088, then at 1.4178, and then at the 1.4226 and 1.4340 levels. Any of these upside/downside levels can easily be broken this week and the probability remains high for a EUR/USD range break in the days ahead, especially with all the fundamental, monetary policy, and geo-political events going down.
That should about cover things for the week ahead. Like I said at the start, good risk management should be at the forefront of your trading decisions at least over the next 48-hours and especially on Thursday. If you find yourself on the wrong side of the market it's always easier to recover from a small loss than it is to make up when you let a position run away from you.
Finally one last quote from Jesse Livermore:
"All through time, people have basically acted the same way in the market as a result of greed, fear, ignorance, and hope. This is why the numerical formations and patterns recur on a constant basis."
Last night in our chat room we got on the topic of how the Federal Reserve and European Central Bank use monetary policy, verbal rhetoric, and geo-politics to move their respective currencies up or down. And wouldn't you know, as fate would have it, just a few short hours later the ECB went on an extremely well coordinated and choreographed campaign to talk the euro up against the dollar...
Today's update is going to be short and sweet because I only want to cover what the ECB did to surge the euro against the dollar and then to talk about tomorrow's monumental fundamental event that will get the markets moving once again.
Here's how the ECB tag teamed the dollar today... this is what they said and in the order in which their coordinated actions took place:
0215 EST - ECB Trichet: "Interest rates are appropriate; fiscal credibility needed for confidence"
In a matter of seconds of Trichet's comments hitting the news wires the EUR/USD took off from the 1.3840 level and never looked back. And in case it's not obvious enough, the reason why this comment was very euro positive was purely based on the fact Trichet said he's not raising rates. Interest rates and interest rate probabilities drive markets, bottomline.
Next...
0322 EST - ECB Trichet: "ECB obliged to preserve price stability; ECB rates are appropriate"
Next...
0429 EST - ECB Noyer: "April indicators show economic situation is less bad"
Next...
0448 EST - ECB Noyer: "Current ECB rate is appropriate"
Next...
0618 EST - ECB Bini Smaghi: "Everyone agrees recovery possible in 2010"
Next...
0621 EST - ECB Ordonez: "Sees inflation positive by year end"
Next...
0803 EST - ECB Ordonez: "Interest rates are appropriate"
Next...
0900 EST - ECB Weber: "Low rates can cause price bubble; ECB has used its room to cut rates; No need for ECB economic stimulus measures"
Next...
0930 EST - ECB Nowotny: "Signs financial markets are past the worst"
Next...
0958 EST - ECB Weber: "ECB has decisively used rate leeway; ECB current measures will hit the mark; ECB won't be influenced on exit strategy"
There should be zero mystery why the euro moved almost 300-points bottom to top today. With six different ECB's all saying interest rates will not be cut, economic conditions are getting better, and that the ECB will not go down the road of loose and sloppy monetary policy we can clearly see what a strong effort the ECB made to talk the euro up against the dollar.
This is very cut and dry stuff. The Fed does the exact same thing and this is how they control the euro and the dollar and the smart money knows exactly what to do when the central banks give the green light. Today's EUR/USD move is a great example for why I am so against charts and technical indicators because they stand no match for real factors that move these markets. I encourage all traders to keep up with the Fed and ECB because they really make trading simple and easy, especially on days like today when they come right out and tell the markets to buy the euro and sell the dollar.
FOMC:
If you think what I'm saying about how the central banks have the power to move and control markets is a bunch of crap, please read this commentary I wrote after the Fed's FOMC meeting back on 18-March.
For tomorrow's FOMC event, here is what's at risk for the US dollar:
The Fed announces it will expand it's program to monetize government debt
The Fed announces it will purchase more mortgage-backed securities
The Fed tells the markets it has no plans to raise rates in the foreseeable future
The Fed tells the markets inflation will go negative or remain extremely low for a long time
The Fed tells the markets there is deflation in the US economy
The FOMC could help the dollar if they say:
They are ending their program to monetize government debt
They are immediately suspending any more purchases of Treasuries
They are concerned about inflation
They are going to raise interest rates in the near-term
The credit market is absolutely wrecked and they are concerned about another credit freeze
The US economy will continue contracting
The unemployment rate is going to 12% or higher
I think scenario A is much more probable and likely as opposed to scenario B. And because of the risk the Fed will announce it's going to keep buying Treasuries in order to stabilize interest rates I have strong caution about the dollar heading into this FOMC event. I will say this, the skeptic in me is still questioning why the ECB went on such a concerted effort to make sure the euro rose against the dollar today and I'm wondering why they chose the day before the FOMC to talk the euro up?
We know the Fed and ECB work together to support or repress their respective currencies so we should not rule out the possibility the Fed may say or do something to strengthen the dollar against the euro tomorrow. Bottom line, I don't trust any of these central banks, I think they are capable of anything and I'm not even going to consider attempting to trade against either one of them.
So from a risk management standpoint I'm going into "safe mode" between now and the FOMC. Sure it could end up being a boring non-event but if it's not I'll be ready for whatever the Fed throws our way. Any monetary policy or verbal rhetoric the Fed uses to devalue the dollar will be an instant trade signal for me, just like it was back in March... if the Fed says to sell the dollar again, I'm selling the dollar without a second thought.
Be smart with your risk management and your money, don't fight against these central banks because the market will steamroll you... and consider that sometimes the best trade is no trade at all.
Dollar and Yen rally as equities and commodities plunge:
For the start of the trade week it's been nothing but a sell-off for all higher-risk, higher-yielding markets. In yesterday's update I issued a pretty strong warning that the equity, commodity, and Forex markets were ready to break their ranges and that's exactly what played out today... spot gold, spot crude, the S&P 500, S&P 500 futures, the Dow and Dow futures all broke their ranges to the downside. The only market that didn't quite make a range break was the higher-yielders in the Forex market although we did see the EUR, GBP, AUD, and CAD come under strong downside selling pressure against the USD and JPY.
Spot gold was one of the first correlated markets to break its range and the move ended with gold making multi-month lows, falling all the way to the $918 level before slightly recovering in the NY afternoon session. But it was the S&P 500 futures which led the way for these markets to break their ranges. The S&P sell-off began around the 918 level and easily crashed through key support zones making it all the way under the 890 level.
The S&P 500 cash market lost all of its 2009 gains today on its range break which was helped along by spot crude's move below the $67 level. Crude was beat up pretty badly and lost over 3.7% of its value today and this helped keep the dollar in positive territory against the euro and pound sterling.
Speaking of the euro, we had a brief moment where some central bank rhetoric gave it a boost against the dollar this morning... around 1011 EST ECB Trichet gave the euro a bump with these comments: "Eurozone interest rates appropriate for now"
Within seconds of Trichet's comments on rates hitting the news wires the euro took off, moving back up to the 1.3900 level and gaining about 50-points based on his comment. But as soon as the market knocked out stops sitting at the 1.3900 level, within 90-minutes the EUR/USD was back to the point of lift-off as the S&P 500 and crude oil came under heavier selling pressure, pushing the euro lower and off its highs of the day.
When it was all said and done the carnage on Wall St. was ugly... US equity markets put in their worst performance in a two month's time.. the Dow Jones lost 200-points and the S&P 500 closed down 3% and losing every penny its made in 2009. None of this should come as a surprise to traders and is why I put such a strong emphasis on these range breaks in the weekly update... all the fundamental signs were there and the price action and price patterns were screaming this was ready to happen.
Of course tomorrow's a new day and I can't predict if this will be a one day trend or if it will be the direction the markets move this week but it will take some very good news or better than expected fundamental data to turn things around quickly.
Tuesday trading:
I went on another trading marathon today to take advantage of the volatility so today's update will be a little abbreviated but I want to cover a few issues for us traders to be mindful of tomorrow. First, between 0200 EST and 0400 EST a ton of Eurozone fundamental data will be released and it's all connected to the consumer, manufacturing and service sectors so you can be sure the markets will react to the data should we get any upside or downside surprises here. And then at 0900 EST the Belgium business report will be released along with a speech by ECB Weber. Trichet tried to talk the euro up today but with limited success so if you're trading the EUR/USD on Tuesday pay attention to the data and the rhetoric that comes out of the ECB.
At 1000 EST we get the latest Existing Home Sales report and the House Price Index data. Keep a watch on the HPI because it's connected to inflation/deflation. I'm still all about the inflation data and still convinced deflation remains a bigger issue than inflation right now. One of the big reasons the US has a deflation issue is tied directly to the sharp decline in housing prices. If the HPI continues moving deeper into negative territory we have a growing deflation issue and this is not something the markets will be too happy about.
At 1230 EST Obama will speak and then of course we have our other big fundamental event of the day which is the mega $40 billion 2-year note Treasury auction. The results of the auction will be released around 1300 EST and should it turn out sloppy with a high yield I would expect Wall St. to react negatively.
I see the possibility the dollar could stay on a firmer footing right into Wednesday's big FOMC event and then once again all bets are off because there's no telling what the Fed will say on Wednesday in terms of the future of interest rates, monetizing more debt, economic stimulus, and the state of the US economy.
The EUR/USD managed to hang on to its range today as it stayed well above the key 1.3753 level. The Asian session could easily bring more selling tonight, especially on the yen crosses. I am expecting to see the Nikkei sell-off and I'd be shocked if anything different happened. A big sell-off in Tokyo would likely cause more dollar and yen strength across the board so if you're trading this evening do yourself a favor and keep a watch on the correlated markets as they will serve as a great guide and trade indicator just like they did during the European and NY sessions on Monday.
EUR/USD key levels will be posted before Wall St. opens tomorrow and as always please be smart with your risk and money management over the next 24-hours as I'm expecting the volatility and price swings to continue.
Hello, I hope you had a peaceful and restful weekend and you've come ready to trade this week because I think we're going to see some sharp moves over the next five to ten days. Trying to "predict" the markets and what they will do at a future point in time is mostly anexercise in futility and not something I really care to burn brain cells doing, but I will say this, I feel strongly enough about the potential to see range-breaks in the commodity, equity, and Forex markets this week or next or both that I want to put it out here right at the start of the update
I'm giving the potential for the markets to see range-breaking price action as high as 90% probability for this week and or next. The basis for my opinion is threefold and listed in order of importance:
Human behavior's affect on price action
Central bank/monetary policy factors
Fundamental factors
On point number one, which I give the heaviest weighting and the foundation for my opinion and probability, I think it's time for a little fear or greed to return to the markets. It's the emotions of fear and greed which drive risk appetites and risk appetites drive money-flows and money-flows drive price action. As complex as these markets are, especially the Forex market, what actually makes the market move is quite simple -- fear and greed. There's really not much more to say on this point, it is what it is. Patterns of behavior--
I spent some time this afternoon analyzing the recent price action and patterns of price behavior of the EUR/USD, S&P 500, and crude oil and all I could think about was one of my old trading mantras... the more things stay the same, the more they need to change...
The EUR/USD has been spinning its wheels as the pair has been stuck in a fairly tight range over the last several trading session. What's kept the euro stuck in a tight range is the fact crude oil and the S&P 500 have been failing to break to new highs ever since 10-June. Spot crude's topped out just above the $73 level while the S&P 500 and S&P 500 futures have topped out just above the 950 level. Both crude and the S&P 500 topped out within 24-hours of each other and since 11-June all three of these correlated markets have steadily declined in price value... not a coincidence...
On the exact same day and exact same time frame spot crude topped out, the EUR/USD also topped out... again, not a coincidence... both spot crude and the euro hit a wall to the upside at 1000 EST on 11-June and have both subsequently fallen in tandem. The euro failed at the 1.4175 level while spot crude failed at the $73.25 level. Seeing a pattern here?
On the downside spot crude has found support at the $69 level or just a few pennies under while the S&P 500 has been bought at the 900 level and the EUR/USD just a few ticks above the 1.3750 level. As most of you know I think candle charts and technical indicators are retarded and are the biggest contributor for why 90% of all retail FX traders remain perpetual losers, but I do believe it's very important to be mindful of support and resistance zones but to locate them using the actual price action and price behaviors of these markets.
We can clearly see the EUR/USD, crude oil, and the S&P 500 have continued to move in tandem with each other, to somewhat varying degrees, but the overall correlation has remained intact and so I believe each market will break their ranges in time frames that are within very close proximity to each other. Predicting when we get our range-breaks is not something I have any ability to do and I really don't care because the signs will be obvious as its happening. The "how" part is the easy part and that's where fundamental, geo-political, and monetary policy factors come into play...
Record breaking Treasury auctions this week:
One of the biggest fundamental and monetary policy factors that could lead to a stronger surge in price action are the various debt auctions the Treasury will hold on Monday through Thursday. The Treasury is going to pimp out the largest chunk of US government debt in history this week. In total, the Treasury is set to auction $104 billion in fresh 2-year, 5-year, and 7-year notes in addition to shorter dated issues early in the week. The Treasury will sell $40 billion 2-year notes on Tuesday, $37 billion 5-year notes on Wednesday and $27 billion 7-year notes on Thursday.
The way this fundamental and monetary policy factor can lead to either euphoria (greed) or risk aversion (fear) is purely based on how sloppy or successful the auctions are. If market participants decide the Treasury is over-supplying debt they will withhold their money-flows which will force the Treasury to drop their price and pay a better yield in order to sell the debt. Conversely, if participants are cool with the supply of debt, there will be a strong bid-to-cover ratio, a favorable yield, and a healthy number of indirect bidders.
Should any of the auctions turn out sloppy it's possible to see Wall St. react negatively and a sell-off on the Dow and S&P 500 would drag the EUR/USD and the other higher-yielders lower against the dollar and yen. The results of each auction will be announced right at or just after the 1300 EST time frame on the day they occur. Ideally the markets would like to see the US government have to pay as little as possible to repay their debts, so that factor is what you really want to be on the lookout for this week during these Treasury events.
FOMC monetary policy event:
Wednesday's FOMC interest rate and monetary policy event is another major factor happening this week that could lead to a volatile surge in price action. For some ridiculous reason Fed Funds Futures was showing a 55% probability of the Fed raising interest rates by December 2009 but that probability has since dropped 10bps over the past week. So, one of the main things market participants will be looking for is any clues or hints as to when the Fed may become hawkish on interest rates.
In my opinion, the Fed will keep the Fed Funds target rate as low as possible for as long as possible. I am not forecasting any interest rate hikes in 2009 because I see no signs the Fed is ready to reverse its course of loose and sloppy monetary policy. But, interest rate monetary policy is not the only issue market participants are concerned about right now...
The markets will also be looking for any indication for Bernanke to up the stakes on his debt monetizing program. Any announcement or indication the Fed is going to expand it's $300 billion program to buy US sovereign debt will have a nasty impact on the dollar, end of story. Should the Fed tell the markets they are flat out not going to buy more debt the dollar may actually gain some ground.
The next factor that can move the markets is in relation to any plans or ideas the Fed has on cleaning up the enormous amount of economic stimulus pumped into the system the past 9-months. The Fed has spiked the money-supply and velocity of the monetary base in order to repel the worst effects of the global recession and disinflationary environment. On a seasonally adjusted basis the latest M1 figures from the Fed show M1 rose to $1.63 trillion while M2 rose to $8.35 trillion. M2 is on crack right now, it's up by over 10%, so if the Fed wasn't more concerned with the disinflation I keep talking about they would never spike the money-supply as much as they doing right presently. But what the markets want to know is when the printing presses are going to slow down and the Fed is going to mop up the mess. Finally, the markets will want to know the Fed's latest assessment on the economic situation in the US. In recent weeks the Fed's been bipolar with their views on the US's recovery. Some Feds are saying the recovery is ready to happen in Q3 while others are saying the second half of 2010.
To sum it all up, here's what you will want to be on the lookout for:
Future interest rate monetary policy
Indication on whether the Fed intends to expand or contract monetizing debt
Direction from the Fed on how they will deal with the economic stimulus pumped into the system
The Fed's view on current and future economic conditions in the US and how this will potentially affect future monetary policy actions
Market participants are always most concerned with the future... a healthy risk appetite brings a desire for higher yields and a greater rate of return while the mitigation of risk causes money-flows to go into so-called safer havens like the dollar and yen. I have no idea what the Fed is going to say or do on Wednesday but it will not be hard to figure out how the market will react bearing those factors in mind as we get the FOMC monetary policy statement. Critical fundamental and central bank events on this week's calendar:
Beside the Treasury auctions and FOMC, the crude oil, S&P 500, gold, and EUR/USD markets will be reacting to the following fundamental and central bank events:
German IFO (Monday 0400 EST)
ECB Trichet speech (Monday 0800 EST)
German Consumer Confidence (Tuesday 0200 EST)
German Manufacturing and Services PMI (Tuesday 0330 EST)
Eurozone Manufacturing and Services PMI (Tuesday 0400 EST)
ECB Weber speech (Tuesday 0900 EST)
Existing Home Sales (Tuesday 1000 EST)
Core Durables (Wednesday 0830 EST)
New Home Sales (Wednesday 1000 EST)
Crude Oil Inventories (Wednesday 1030 EST)
Eurozone Industrial New Orders (Thursday 0500 EST)
Initial Claims (Thursday 0830 EST)
Final GDP and Final GDP Prices (Thursday 0830 EST)
Fed Bernanke testimony (Thursday 1000 EST)
German regional CPI (Friday)
Core PCE/Personal Spending/Personal Income (Friday 0830 EST)
Michigan Sentiment (Friday 0955 EST)
Of course various ECB and Fed comments can hit the wires at any given moment throughout the trade day in order to push the markets one way or the other. The ECB was using verbal rhetoric to talk the euro up, then they switched to using verbal rhetoric to talk the euro down... what they will do this week is anybody's guess, it all depends on their objectives and agenda for the euro and Eurozone, but don't get caught off guard this week if they decide to talk the euro up or down.
Price action trading--market timing,short-squeezes and stop loss runs:
If you were trading last Friday I am sure you will remember the volatile spike the EUR/USD made between 1130 EST and 1200 EST. In case you missed it, the euro basically spiked up 70-points in the span of 30-minutes and likely steamrolled a good number of retail Forex traders because that's exactly what that type of move is supposed to do, it's been repeated hundreds of times in the tradeable history of the EUR/USD and it will be repeated again hundreds of times in the future.
I wanted to take the time to comment on this because the price action move the euro made combined elements of much of what I've been teaching traders the past 2+ years. This will also serve as a good reminder for traders who have forgotten these core trading principles of the Forex market and for those who are new to understanding the methodology for how I trade...
The 70-point spike incorporated the following elements:
A market timing pattern that has been repeated hundreds of times
A price action pattern that has been repeated hundreds of times
A textbook short-squeeze pattern
A classic stop loss run
Market timing pattern; short-squeeze; stop loss run--
The market timing pattern that was repeated on Friday and has been repeated countless times in the past is for the USD and JPY to weaken against the EUR and GBP into the London close. For those traders that were in our chat on Thursday when London was closing we reminded you of this very thing, just 24-hours before the same exact pattern was repeated on Friday, so hopefully it was still fresh in your mind...
Take a look at when the 70-point spike took flight... it started at the 1130 EST 30-minute opening at the price of 1.3930. 1130 EST is the last 30-minutes of London and during the last 30-minutes London was open the euro surged all the way to the 1.4000 level by the 1200 EST 30-minute open. What happened as soon as London closed? The euro immediately stopped dead in its tracks and reversed which is no coincidence.
The GBP/USD also made an equally impressive move during the same exact time frame the EUR/USD made its move. At 1130 EST the pound sterling took off from the 1.6450 level and spiked up to the 1.6550 level by 1200 EST before doing a 180 just like the euro. I personally capitalized on the pound's move, but I'll get to that in a moment...
Does the dollar and yen always weaken against the euro and pound sterling into the London close? No, of course not, there's no such thing as always in this market, but based on the 15,000+ EUR/USD 30-minute price opens I've written in my price action notebooks, this is a market timing pattern I've observed get repeated over and over and over again. Based on history and repeated price patterns, the higher probability during London's close is for the dollar to weaken against the euro. In fact, this is one of the very first market timing patterns I taught traders way back when at the old FXI community. I have stacks of notebooks filled with EUR/USD 30-minute price opens that prove this market timing pattern.
The way I know this was a textbook short-squeeze and stop loss run is for a few reasons that go beyond what history shows... first, the time of day, which we've already covered. The second reason, there was absolutely no fundamental or geo-political basis for the move. Volatile spikes can routinely occur when a piece of fundamental data is released, a central banker makes a surprise comment on monetary policy, or an unforeseen geo-political event goes down, but none of those factors played a role between 1130 EST and 1200 EST on Friday. There wasn't any fundamental data or unforeseen geo-political event or surprise central bank rhetoric to trigger the spike, so that was pretty much a dead giveaway the market was squeezing traders who were short the EUR/USD and GBP/USD.
The London close also gave the market makers the perfect opportunity to go on a stop loss run while squeezing the short-sellers. How do I know this was also a stop loss run? Easy, not only have I seen this exact type move countless times, it's clear just by looking at where the EUR/USD and GBP/USD stopped and reversed... the euro knocked out stops that were sitting right on a 00 level (1.4000) and the pound sterling knocked out stops sitting right on a 50 level (1.6550). Retail Forex traders are notorious for putting their stops on 00 and 50 levels, especially traders who do not understand the principles of how stop loss triggering works.
Remember what almost always happens after these types of moves happen? The market almost always returns to the point of lift-off... with no fundamental or geo-political basis behind the move, the move is unsustainable because there was no true conviction buying to push the market from point A to point B. This is the final sign the spike was a textbook short-squeeze and stop loss run... as I'm writing this commentary I went back and checked my numbers and see that by 1630 EST on Friday the euro was right back to the point of lift-off at the 1.3930 level... not a coincidence.
Trading the pattern--
Whenever I see a classic stop loss run, especially on a Friday during London's close, 99% of the time I'm going to trade against the move without even a second thought. The way I decided to capitalize on the fake move was by trading the GBP/JPY. The pound-yen was already showing me a price pattern of being over-extended at the 159.00 level, so when I saw the spike push it back there I was just waiting for the spike to exhaust itself, for the upside price action to slow, for London to close and get out of my way and then I was going to make my move. Here's the exact trade I took:
Not only was I playing the snap-back on the over-extension of the spike up but my trade and my bias was confirmed as I saw the Dow futures in a free fall at the 1200 EST time frame. Considering the weakness I was seeing in the Dow futures, which dropped almost 40-points between 1200 EST and 1230 EST in addition to all those other price action factors, based on my numbers I was showing better than a 92% probability to make an easy 30-points or more on a GBP/JPY short at the price of 158.80 or higher.
I'm probably making it sound a little easier than it is, this stuff comes purely from experience but it comes by watching price action and learning the market's patterns of behavior instead of watching charts and technical indicators that lag so bad they are incapable of revealing what's really going on behind the scenes. Last thing I'll say on this topic -- always know what time of day it is in relation to which markets are opening or closing, especially London. You may not always be able to capitalize on these type of moves but if anything you'll be "smarter" than the market and save yourself an unneeded loss. Trading:
I've pretty much covered every fundamental, monetary policy, and price action factor I'll be using to gauge the markets and pick my trades. I don't need to be a bear or bull, I'm just going to continue going with the flow, I'm not going to fight against the market correlations, the fundamentals, the central bankers, or the market's sentiment, I'm just along for the ride...
The only factor I haven't mentioned is geo-politics. We still have escalating geo-political situations in both Iran and North Korea. Iran exports about 4M barrels of oil a day and of course wacko Kim Jong Il is capable of anything, he's really got nothing to lose at this point, so be mindful of potential geo-politcal affects on the markets this week.
As always I strongly encourage all traders to be very smart with your risk and money management, especially if these markets are ready to make their moves and break their ranges. The longer these markets go in a circle in their tight range the higher the probability they need to breakout...
If there's a night where I don't do an update it just means I'm very focused on trading but I will post EUR/USD key levels each morning before Wall St. opens. I hope you have a fun and profitable week... peace to all...
Disinflationary US fundamentals reverse early gains by higher-yielding markets:
The higher-risk, higher-yielders were off to a strong start during the European and early NY session as the markets got better than expected fundamentals out of the Eurozone (ZEW) and hot inflation data out of the UK. Leading into the 15-minutes before Wall St.'s open the S&P 500 futures, crude oil, and the higher-yielding currencies were all up but then quickly reversed within minutes of the latest Capacity Utilization and Industrial Production data releases at 0915 EST. That was the point US equity futures turned south after being up in pre-market trading, crude oil fell from above the $72 level, and the EUR/USD easily slid below the 1.3910 level.
It's no coincidence the dollar and yen gained some ground back and the higher-yielders dropped right after 0915 EST because the newest Industrial Production data showed output plunged by 1.1% while Capacity Utilization printed the lowest in history and Wall St. does not like disinflationary data at all. The data also showed year-over-year production is now down 15% which is a 63-year low.
More signs of disinflation--
One main reason the markets reacted so negatively to today's Capacity Utilization data is because it was more disinflationary than expected. It's important to remember these markets need some inflation or else prices cannot be supported. I know there are quite a few inflation alarmists out there but the data doesn't support this view as evidenced in exactly what we saw today with the Capacity Utilization number. In the simplest of terms, higher output equates to higher prices, it doesn't work any other way. But what we're seeing is contracting output which has led to declining prices.
For further proof all I need to do is look at today's PPI data... Core PPI clocked in at -0.1% which is the lowest in two years and is also disinflationary. Wholesale prices are down 5% year-over-year which is a 50-year low and very disinflationary. There's even more evidence of disinflation when I break down all of the output data from today:
Overall manufacturing down 1%
Business equipment production down 1.4%
Construction production down 1.0%
Mining production down 2.1%
Utility production down 1.4%
Consumer goods down 0.8%
Non-industrial supplies down 1.4%
It's no secret the Fed is running the printing presses and attempting to spike the monetary base but at this point their loose and sloppy monetary policy is not reversing the disinflation that exists in the economy. Disinflation goes hand in hand with deleveraging and the reduction of inventories and both the US and world economies have not finished that process yet. Today's inflation connected fundamentals are just another reason I do not believe in the rally we've seen on Wall St. the past few months because I know equities need price inflation to remain supported and that factor does not exist at the present.
The S&P 500, Dow Jones, crude oil, gold, the euro, and pound sterling will not be able to maintain a sustainable rally until the markets work themselves out of this season of disinflation, bottomline. It's no wonder at all that on a day with this kind of data the S&P 500 and the Dow both close down 1% and crude oil lost 3%. And if you need more evidence for how closely the market watches inflation data, just take a look at what the GBP/JPY did as soon as the latest UK inflation data hit the wires... at 0430 EST this morning the hot UK inflation data pushed the GBP/JPY from the 157.60 level up to a high at the 160.00 level and the GBP/USD soared from the 1.6357 level to the 1.6500 level, it's very easy to correlate the data and the price action move...
ECB uses the "d" word:
Sticking to the theme so far in today's update... take a look at what ECB Tumpel-Gurgerell said at 1201 EST today:
"Current negative inflation is due to base effect from last year; not concerned about sharp rise in inflation now"
What did the euro do after her comments hit the wires? It dropped a good 40-pips. She wasn't the only ECB dropping the "d" word today. Here's a quote from ECB Mersch made at 1422 EST: "Europe experiencing disinflation"
As you probably know from reading my blog I'm most concerned with the disinflation situation in the Eurozone compared to the US and UK. Both the US and UK are printing enough money and monetizing billions of sovereign debt that it should mitigate total deflation and keep the disinflation under control but the situation is different in Europe and this is another fundamental strike against the Eurozone and the euro.
Eurozone inflation is the lowest since record keeping began in 1996. The ECB has a 2% inflation target and Eurozone inflation is well off that mark. In fact, the ECB has stated dozens of times they prefer to not see inflation dip below the 2% level and this is for all the reasons we talked about above. So in the months ahead keep tabs on the inflation situation in the Eurozone especially if you trade the EUR/USD because if the disinflation situation in Europe gets much worse we may see the ECB take some extreme measures to reverse this trend.
Wednesday trading:
The markets will get plenty of fundamentals to play with tomorrow as there's quite a bit of data on the books again. If you trade the pound sterling you will want to be mindful of the employment data and the MPC Meeting Minutes released at 0430 EST. There really isn't much data out of Europe but out of the US we get more inflation data with the CPI and Core CPI releases.
The two other big events are Crude Oil Inventories at 1030 EST and of course Bernanke's speech at 0900 in DC. All eyes and ears will be Bernanke to see if he sticks to the latest themes we're hearing out of the Fed which has been a little more solemn on the US economy and the potential for a fast recovery.
Once again the center of the universe will be crude oil... spot crude's managed to find buyers at and just below the $70 level but within the price action I can see some clear attempts from some market participants to push crude lower. A sustained break of the $70 level and then the $68 level should put a good deal of downside pressure on currency pairs like the EUR/USD, USD/CAD, GBP/USD, and EUR/JPY. I'm sure if crude oil gets too low there will be a "surprise" attack on a pipeline from Nigerian rebels to help push prices higher but by far the biggest crude related event will be the inventories data. The past few weeks inventories have shown a big draw in addition to refinery utilization dropping and those factors have been very supportive of crude. Should we see a reverse of this trend I'd expect crude to come lower, dragging the euro and S&P 500 with it. Trading--
My bearish dollar bias remains intact but as I mentioned on Sunday I am still open to buying the dollar and yen against the majors and crosses in light of the weakness now being seen with equities and commodities. In today's trading Europe pushed the markets up and Wall St. reversed them all and I'm not ruling out seeing a similar move tomorrow. Either way, I do expect a pick up in volatility and expect to see some stronger price swings in the markets compared to today.
As always, use proper risk and money management in your trading, it's not worth over-leveraging during these choppy and ill-liquid market conditions. EUR/USD key levels will be posted in the morning.
Euro plunges from sharp drop in crude, S&P 500, and central bank rhetoric:
Today's strong market volatility can be best described by looking at what the world's three leading correlated markets did:
1. Crude oil dropped below the $70 level, losing over 2% on the day 2. The S&P and S&P 500 futures both lost over 20-points, closing down 2.4% on the day 3. The US dollar Index rose over 1.25% on the day
Those three factors about sum it up to explain why the EUR/USD, GBP/USD, EUR/JPY, and GBP/JPY came under pressure, each losing several hundred pips to the dollar and yen respectively and crude oil was clearly the main culprit responsible for leading the higher-risk, higher-yielding markets lower which boosted the dollar and yen against the majors and crosses. In yesterday's update one of the reasons I put such a strong emphasis on the tight correlation that exists between the EUR/USD - crude oil - S&P 500 - geo-politics was for exactly what we saw play out in the markets today.
To re-cap today's price action... between Tokyo's open and Wall St.'s open the S&P 500 futures made a double digit drop which sent the EUR/USD from the 1.4000 level at down to the 1.3870 level by the time Wall St.'s opened this morning. As soon as Wall St. began trading both the Dow and S&P 500 sank again, pushing the euro even lower. Then the dollar was further helped from central bankers at the Fed and ECB. At 1021 EST Fed Evans gave the dollar an added shot against the euro with this comment:
"Sees rate hike when economy grows"
And then at 1100 EST ECB Papademos made comments that put even further downside pressure on the euro, sending the EUR/USD down over 60-pips in less than thirty minutes... Papademos said:
"Euro-area banks face USD$283 billion more losses by 2010; commercial property market source of risk; risks to financial stability remain high; banks should make use of government guarantees on new debt"
Papademos's negative comments sent more fear and risk aversion into market participants, easily pushing the euro below the 1.3780 level and then crude oil's clear break of the $70 level in the NY afternoon session further pushed the EUR/USD to hit the 1.3750 level. Now, there's a little more to this story that we need to take a look at...
ECB gives markets negative view on Eurozone banks:
As I mentioned in the update yesterday, the G8 voiced strong concern about the European banking system and now today we heard from the ECB on this issue. The ECB has done little to publicly address the systemic risk still lingering within the European banking system but the ECB decided they would talk about it today. ECB Papademos delivered the message about Eurozone banks losing at least another USD$282 billion by 2010 and there were even more alarming comments... the ECB also said:
"Hard-to-value assets have remained on bank balance sheets and the marked deterioration in the economic outlook has created concerns about the potential for sizable loan losses"
One ECB estimate shows that the total number of Eurozone banking losses from the time the credit crisis started in 2007 through 2010 could total as much as USD$649 billion. ECB Papademos further stated:
"There is no room for complacency because the risks for financial stability remain high, also bearing in mind that the credit cycle has not yet reached a trough; banks should be encouraged to take advantage of the governments' commitments for support and strengthen their capital buffers; the profitability of major euro-area banks has been eroded and the prospects for a significant turnaround in the short term are not promising"
ECB Nowotny also gave very euro-negative comments this afternoon, saying:
"Europe is in a very deep recession; very dangerous to consider exit strategy too soon; interest rates may stay low for quite some time"
There's no telling how much more rhetoric we will get out of the ECB on the European banking system but this is a very big geo-political issue that directly effects the Forex markets so whenever you hear those types of negative comments out of the ECB about their own banking system you can be sure the euro will fall to the dollar.
Beware of geo-political rhetoric out of BRIC Summit:
Even before the start of Tuesday's first ever BRIC Summit the geo-political rhetoric was flying as Russia's Finance Minister Kurdin said Russia has full faith in the US dollar and that it is too early to talk about replacing the dollar as the world's reserve currency and Kurdin's endorsement of the dollar was just another contributing factor to the dollar's rise against the majors today.
Why does the BRIC Summit matter to the Forex market? Easy, collectively the nations of Brazil, Russia, and India, and China make up 15% of the entire world's economy and what's even more important is that they collectively hold nearly 50% of the entire world's currency reserves. BRIC nations have both the geo-political clout and collective buying power to move markets, pure and simple... just look how the dollar positively reacted to Kurdin's comments for evidence of this.
For all the differences in the four nation's political and social ideologies, each BRIC nation appears to be speaking the same language when it comes to the role of the US in the global marketplace. BRIC wants the US to take a declining role as the world's economic superpower and each BRIC nation believes they deserve to be viewed as relevant and a force to be reckoned with. I am not expecting any specific policy to be set or for any major agreements to be formulated but what traders need to be on the lookout for is potential market-moving rhetoric, either pro or anti dollar. As much as their ideological differences present too many challenges to solidify policy, with BRIC's biggest beef being "the unheard voice" it's entirely possible they will flex their muscle as their way to show the world they can move markets. Fed eases market fears, gives added confidence in dollar:
Just as the ECB was out talking the euro down today the Fed was out talking the dollar up. You starting to see a pattern here? If you read my blog you will know one of the biggest fundamental factors stacked against the dollar is the fact the Fed started monetizing government debt. The market's fear that the Fed would monetize even more than $300 billion in US debt kept a tremendous amount of downside pressure on the dollar since 18-March. Well today the Fed used some verbal rhetoric to give the markets confidence this will not be the case.
Fed Fisher said:
"Senses no pressure from Obama to monetize US deficit; not convinced that backup in rates due to fear Fed will monetize debt, largely measure of supply and demand; Fed constantly working at an exit strategy"
Fed Evans was singing from the same page, saying:
"No need to boost Treasury, MBS purchases for now"
I can't explain why geo-political market-movers are talking the US dollar up all of the sudden, maybe they were overly pressured by China or maybe there are other reasons. I don't really care, I trade accordingly to what the Fed and ECB says, but here again, I encourage traders not to get stuck on their charts and tech indicators and to pay as close attention as possible to the central banks as their words are what set market direction just as we saw today.
Tuesday trading:
I hate sounding like a broken record and being repetitive but in terms of trading and market bias, there's nothing else I can do but repeat what I posted in yesterday's update:
At least at the very start of the week I'm going to ease back on my prior anti-dollar and anti-yen bias. I'm remain a strong dollar bear but I'm going to keep an open mind to opportunities to buy the dollar against the euro or to buy the yen against the majors only if one or more of the following fundamental/geo-political/market correlation factors exists:
Crude oil falls
The S&P 500 sells-off
Negative fundamental and economic data causes risk aversion
Geo-political tensions between the US, Israel and Iran lead to safe-haven money-flows
North Korean geo-political tensions of nuclear war send safe-haven flows into the dollar
Fall out from the G8 pressures the euro
Central bank rhetoric causes fear and risk aversion and money-flows out of higher-yielding markets
Those are my seven key indicators and trade triggers this week in addition to using my normal price action patterns and probabilities based on price behavior of course.
Crude oil, the S&P 500, the fundamentals, and the central bank rhetoric were all against the euro and all in favor of the dollar today so I bought the dollar against the euro... I'm just keeping it simple and sticking to the game plan. Traders who used the market correlated variables listed above would have been on the right side of the market today for their trades and market bias. And I'll repeat my encouragement to traders to forget the charts because if a chart is saying to buy the euro yet crude oil and equities are falling, the chart is dead wrong, end of story. If a tech indicator says to buy the euro and the ECB is out talking the euro down or the Fed is out talking the dollar up, the tech indicator is dead wrong and will cost you money. KEEP IT SIMPLE AND DON'T FIGHT THE MARKET!
Mega inflation fundamentals tomorrow--
The Forex market will see more rounds of volatility tomorrow as we get key inflation figures out of the UK, the Eurozone, and the US. For the UK and the pound sterling I do not expect a negative print on their CPI and Core CPI data but should we get a major downside shock here I expect nothing less than a heavy sell-off on the GBP/USD and GBP/JPY. A surprise rise in UK consumer inflation would obviously be a good thing for the pound, so if you trade the GBP do not get caught off guard at 0430 EST on Tuesday.
The Eurozone has the biggest deflation issues and I believe if we see negative or below expected prints on their consumer inflation data it should give market participants another reason to sell the euro against the dollar. I'd be very cautious with any euro longs ahead of their CPI release at 0500 EST.
Inflation data is just the tip of the iceberg tomorrow as the markets will also have to contend with the latest German and Eurozone ZEW data and a ton of fundamentals out of the US like Building Permits, Housing Starts, Industrial Production, Capacity Utilization and more Fed speeches.
For yen traders don't forget the BOJ's interest rate event, monetary policy statement, and interest rate press conference which typically takes place after midnight EST. As you can see there is a ton of crap going down tomorrow and I can't say enough to be sure you're practicing strict risk and money management disciplines and staying smart to keep up with all the fundamental and geo-political factors moving these markets.
As has been the case in recent weeks, for this trade week, price action and market direction will be closely linked to key fundamentals and geo-politics as those two leading market factors dictate risk appetite, the flow of money, and overall market sentiment.
On a fundamental basis, the dominate themes will revolve around inflation, housing, and central bank monetary policy. From a geo-political perspective, market participants will most closely focus on rising tensions with North Korea, fallout from Friday's Iranian presidential elections, this weekend's G8 meetings, and a heavy dose of central bank speaking events that are on the calendar the next five days.
And before we go any further, let there be no mystery -- crude oil and the S&P 500 are the two linchpins that will make or break these markets... crude has been on an incredible run so far in 2009, gaining over 60%. With crude's strong comeback its allowed the S&P 500 to make a considerable move off its mid-March lows and leading the EUR, GBP, CAD, and AUD to make substantial gains against the USD.
When the market can no longer sustain light sweet crude at these elevated levels, the S&P 500 and the higher-risk, higher-yielding currencies in Forex will all fall. I do not have the ability to predict when crude oil will top out but from a pure trading standpoint this week, I will use this commodity as my guiding light because the game will up for Wall St. and the dollar will get a boost when the current run on crude peaks and we see a reversal and then a sell-off in the US equities markets. Traders will be well served to closely monitor the price action of crude oil this week. G8 questions health, sustainability of European banking system:
It's no secret the European banking system is as fractured if not more fractured than the US and UK banking systems. On the major financial news networks you hear little talk of how over-leveraged and fragile European banks are but this issue was apparently a dominant theme at this weekend's G8 meeting. Although the G8's communique makes no direct reference to European banks, the talk in the meeting rooms, hallways, and corridors were very negative on the European banking system.
The loudest detractors were from US and UK central bankers and finance ministers in addition to officials from the IMF which wields power in the Euro area. The central banks and finance ministers were raising issue with Europe because the US and UK have already conducted banking stress tests yet Europe is resisting to follow suit. Europe's resistance to conducting their own banking system review raised strong objection at the G8 and UK officials were specifically critical because their view is that irregularities within the European banking system will hamper Great Britain's recovery. US and UK finance ministers want to know what kind of nasty skeletons are lurking in the closet and how much dirt has been swept under the rug.
What the G8 wants to see happen is for European banks to assure the market's they are well capitalized and the only way they see this can be accomplished is through a US-style stress test. When pressed on the matter at the G8, the reaction from European officials was strong... French finance minister Lagarde said:
"Each one of us is following its own schedule; we're not looking at the example of this or that country; we are not hiding anything under the carpet"
Italian finance minister Tremonti said: "In Europe we haven't begun speaking about stress tests"
The IMF said:
"Europe can hardly afford a piecemeal approach which perpetuates uncertainty, leaves private investors sidelined, and allows government involvement in the sector to weigh on overall efficiency"
This geo-political issue could absolutely have a negative effect on the euro should market participants pullback their risk appetites and grow adverse to buying the euro against the dollar. The issues still facing the European banking system are one of the main reasons it is unsafe to maintain an overall bullish bias on the euro and any possible fallout from the G8 raising concerns could definitely put some selling conviction on the euro this week.
OPEC keeps upside pressure on crude oil:
Over the past two weeks OPEC has made it glaringly obvious they want crude oil to at least hit the $75 mark with a preference to see $80 or better. At OPEC's last meeting they urged their members to follow output cuts and just this morning in Amsterdam another OPEC official used verbal rhetoric to help push crude higher... when asked about potentially raising crude output, which would be bearish for crude, he said:
"I don't think so. I would like to see where the real growth is, when the economic crisis reaches bottom and will take off again"
An OPEC oil minister from Kuwait said crude output production will not even be considered until crude rises above the $100 level. OPEC's next meeting isn't until September but as we can see they are doing everything under their power to ensure crude keeps breaking higher in the near-term. OPEC controls 40% of the world's crude supply and as much as they deny they are a cartel, market participants still take their cue from OPEC's verbal rhetoric and policy and as long as OPEC says crude needs to keep gaining it will likely keep gaining.
Beside OPEC talking crude up, refiners continue cutting production and crude oil inventories contract week after week and those are some of the fundamental factors supporting crude. At some point consumers will start feeling the pain and will pullback on their demand. Just in the past two weeks prices at the pump in the US have surged almost 17 cents on average. Prices are still a far cry from the $4.20 levels seen last summer but bear in mind unemployment was at 5.5% last June and is now 9.4%...
From my own fundamental point of view, I do not believe crude oil should be valued over the $75 level but here again I'm not going to fight against it because if the market follows OPEC's lead, crude will keep charging north bringing equities up with it and the dollar lower. Once again I'll repeat my strong encouragement to all Forex traders: watch crude oil this week...
Inflation or deflation? Market focuses on inflation fundamentals:
From a fundamental and economic standpoint, inflation data will dominate the markets this week. If you have followed my blog updates for any length of time you know how serious I take inflation fundamentals because inflation has such a wide impact on prices, price action, and how market participants gauge risk. If you trade any of the major currency pairs or yen crosses you will want to keep this list of inflation fundamental releases in mind:
Swiss PPI (Monday 0315 EST)
UK CPI, Core CPI, and RPI (Tuesday 0430 EST)
Eurozone CPI and Core CPI (Tuesday 0500 EST)
US PPI and Core PPI (Tuesday 0830 EST)
US CPI and Core CPI (Wednesday 0830 EST)
Canadian CPI and Core CPI (Thursday 0700 EST)
German PPI (Friday 0200 EST)
I realize all the talk going around the markets is that inflation is flying but most of the talking heads are clueless about what inflation really is. I'm personally not buying into the inflation story yet. What's important for traders to bear in mind is the different types of inflation and not to get confused by the term "inflation" being used as a blanketed statement. The truest definition of inflation is just printing money, that's all inflation is at its essence, it's running the printing presses.
As much as the Fed denies it, the Fed wants and needs inflation. If the Fed didn't need inflation it wouldn't be running the printing presses right now but the Fed knows what inflation accomplishes and that is a rise in equity and commodity prices. When the Fed spikes the money-supply and monetary base and speeds up the velocity of money what the Fed is doing is manipulating the cause-and-affect of printing money (inflation) -- higher producer and consumer prices.
One of the main reasons I'm more concerned about deflation as opposed to inflation is because of the message the Fed is sending... I'm just looking at the Fed's actions and they are screaming "deflation" right now. Of course the Fed wants the dollar lower and is unconcerned with the recent dollar sell-offs, this is obvious based on their monetary policy but what keeps me more focused on possible deflation issues is the fact the Fed is engaging in deflation-fighting tactics.
Deflation--
I see deflation as the steady and continuous trend of declining and or negative effective demand. Deflation exists when the combined power to purchase controls and prohibits the ability to produce goods and bring them to market at sustainable levels and steadily rising prices. As much as the Fed has the power to control inflation the consumer has the power to control deflation, ultimately one side will win out over the other but for now I see the consumer is still dictating prices.
It is important to understand that the equity markets and housing markets cannot fully recover in a deflationary environment. Banks cannot make money under deflationary conditions and overall growth contracts in relation to how deflation expands. One of the main reasons the pound sterling has gained over 10% against the euro in the near-term is due to the fact overall UK inflation is at somewhat elevated levels and remains in the positive while overall Eurozone producer and consumer inflation is flat or negative, it's very simple stuff.
The UK does not have nearly the degree of deflation as I am seeing in the Eurozone the past few months and this very key fundamental factor leads market participants to sell the EUR against the GBP. By far Europe is under the biggest threat of inflation and it will be very interesting to see how the inflation data out of Europe prints this week. All traders should be mindful for how the inflation data prints this week and what kind of response may come from central bankers based on the results of the data...
S&P 500 and the euro-yen:
I rarely trade the EUR/JPY but if you do you know it was in a fairly tight range last week and struggled mightily to hang on to any gains above the 138.20 level. Out of all the currencies in the Forex market, the EUR/JPY is the one that acts as the thermometer for the global equity markets and more specifically for the S&P 500. Last week the S&P 500 only gained a total of 1% and traded in a constricted range which is what kept the EUR/JPY in such a tight range.
The fundamental correlation between the S&P 500 and the EUR/JPY is fairly simple and basic... when the S&P 500 is lukewarm the euro-yen is mostly stuck in a range, when the S&P 500 surges up the euro-yen flies and vice versa. The S&P 500 barely moved 30-points last week and correspondingly the euro-yen moved just under 300-pips last week bottom-to-top.
From a pure price action perspective, both the equities and currency markets are running out of time to maintain their tight and consolidated ranges. Of course it's possible to see the S&P 500 trade in another tight range that doesn't really go anywhere and should this be the case again, the EUR/JPY may range as well. Both of these correlated markets were stuck last week and I believe it's going to take some really good economic news and data to give Wall St. an incentive to keep pushing the S&P 500 higher. But once crude tops out, the jig is probably up for equities and the yen will gain back ground on the euro. Even when I'm not trading the EUR/JPY I'm monitoring it because of the fact it acts as the perfect temperature gauge for the global markets and risk appetites.
Trading outlook:
At least at the very start of the week I'm going to ease back on my prior anti-dollar and anti-yen bias. I'm remain a strong dollar bear but I'm going to keep an open mind to opportunities to buy the dollar against the euro or to buy the yen against the majors only if one or more of the following fundamental/geo-political/market correlation factors exists:
Crude oil falls
The S&P 500 sells-off
Negative fundamental and economic data causes risk aversion
Geo-political tensions between the US, Israel and Iran lead to safe-haven money-flows
North Korean geo-political tensions of nuclear war send safe-haven flows into the dollar
Fall out from the G8 pressures the euro
Central bank rhetoric causes fear and risk aversion and money-flows out of higher-yielding markets
Those are my seven key indicators and trade triggers this week in addition to using my normal price action patterns and probabilities based on price behavior of course. I encourage traders to spend less time speculating over 8 kazillion different time frame charts plastered with 50 indicators and pay close attention to underlying fundamentals and geo-political factors that actually move markets.
Interest rates and monetary policy--
In addition to the mountain of data this week there are several central banks conducting monetary policy activities and you will want to be mindful of these events:
Plus, there are a ton of central bank speeches this week... everybody from Bernanke to Geithner to Weber to King. If you trade the USD/CAD you will want to keep a close eye on the two speeches BOC Carney will deliver on Thursday. Carney has been trying to talk the surging CAD down against the lowly dollar and he may up the rhetoric this week if the USD/CAD keeps dropping. For Swiss franc traders do not get caught off guard by the SNB as they may use this week's interest rate event to help debase the CHF.
As I noted in last Friday's update, the euro and pound sterling would see a pullback on profit-taking and positioning ahead of the weekend's G8 event and this certainly turned out to be the case on Friday and I expect the euro to possibly remain on weaker footing at the very start of trading on Sunday.
Well that's all I've got for now and should give you plenty to work with and think about as we get rolling on what's shaping up to be another fun week in the markets. If you do well to stay on top of your game, pay attention to the underlying fundamentals and listen to what the central banks are saying you should be profitable. We are definitely in summer trading conditions now as the markets are growing thin so be smart with your risk and money management. EUR/USD key levels will be posted before Wall St. opens tomorrow.
Dollar falls to rising crude, equities, and negative central bank rhetoric:
Once again the dollar was handed more losses to the euro and pound sterling courtesy of crude oil and US equities. The front month crude contract broke the $73 level today, pushing the S&P 500 to fresh 7-month highs. After better than expected US fundamentals (retail sales, jobs) the dollar didn't stand much of a chance against the higher-yielding currencies and their correlated markets as they all made strong upside moves pushing the dollar lower as the USD Index slid back under the key 80 level. 30-year bond auction contributes to dollar weakness--
The strongest move against the dollar came in the afternoon NY session. At 1303 EST the results of the 30-year bond auction were released and it went much smoother than the markets were expecting. What made this a good bond auction which was good for equities, crude, and gold, and bad for the dollar was two main factors:
Low yield
Strong foreign demand
The expected yield for this auction was 4.80% but due to the bidding and healthy demand, the auction high yield was just 4.72% and the 8bps net positive differential between the expected and the actual is very bullish and favorable. If market participants wanted to force the Treasury to pay more to borrow their money for 30-years they would have forced this through a higher yield.
The other factor that made this auction go well was the indirect bidding which came in at 49% vs. an average of just 25.8% and a full 2.6% higher than the previous. Indirect bidders are those from foreigner nations like China and Russia and the fact that foreign sovereign money-flows showed a healthy appetite for US debt helped rally Wall St. and sinking the dollar.
Now despite the strong gains made after the 30-year bond auction this afternoon the equities market dropped into the close which is further proof that participants need news and positive fundamentals to keep buying and once the euphoria wears off, prices drop again. The S&P 500 failed again to close above the key 950 level and this has been a reoccurring theme this week. As I said in yesterday's update I am not a believer in what we're seeing on Wall St. but I'm not about to go against the flow either...
Fed wants dollar to continue depreciating:
Around 1350 EST Atlanta Fed Lockhart gave the markets with more anti-dollar rhetoric:
"USD role as reserve currency may decline; not made up mind yet to increase Treasury purchases"
As soon as those comments from Lockhart hit the wires the dollar took another hit and his rhetoric helped send the euro and pound sterling to their highs. Basically there wasn't a single fundamental, geo-politcal, or market correlation reason to buy the dollar today, it was pressured lower from every side. And reading between the lines on Lockhart's comments I believe what he's saying is that he is open to the idea of seeing the Fed monetize more sovereign debt which is obviously a very USD negative factor.
The Fed still wants the markets to sell the dollar, it's clear as day. When the Fed starts talking about the possibility the dollar will be removed as the world's reserve currency I do not see how it gets any more obvious they want the dollar to continue depreciating in the near-term. In recent years the Fed has not made a single mention of the dollar potentially being dethroned as currency king of the world and now they are changing their tune and I believe this is the Fed's way of assaulting the dollar but in a somewhat subtle manner.
The Fed obviously can never came straight out to tell the markets to sell the dollar, geo-politics don't quite work that way but the smart money, who are the real market movers, know how to read between the lines and they know better than to go against the Fed. And I'm the same exact way... no, my two or three standard lot contracts aren't moving any markets but I know better not to fight the Fed and as bearish as I am on the euro at least the ECB is doing what they can to talk the euro up. The ECB has done nothing lately from a monetary policy perspective or with verbal rhetoric to depreciate the euro like the Fed has been doing to depreciate the dollar.
From a pure monetary policy standpoint the Fed and ECB diametrically opposed to one another. The ECB has acted to make sure the euro still yields at least 75bps more than the dollar, they have not gone down the path of monetizing sovereign debt, they are not running the printing presses to pump euros into the money-supply, their credit standards are tighter than the Feds and overall the ECB has a stricter monetary policy when compared to the loose and sloppy path Bernanke has taken the Fed.
When you combine all of those monetary policy and geo-political factors in addition to the factor of the Fed clearly telling market participants to sell the dollar on its strength you have a situation where the euro continues to gain on the dollar despite some horrific fundamentals in the Eurozone. Almost every day a trader will ask me when I know it's time to change my anti-dollar bias to an anti-euro bias and the answer is simple -- when the Fed stops telling the markets to sell the dollar or when the ECB starts telling the markets to sell the euro.
There may be a season in the near future where the ECB joins the Fed to use monetary policy and verbal rhetoric to depreciate the euro and if I see both central banks starting a currency war I'll likely stop trading the EUR/USD and focus on another pair more exclusively but until then I'll do exactly as the Fed is telling me to do and I'll keep selling the dollar, it's been too easy to do anything different than that the past two months.
Battle of the worsts--
The Fed is in a bit of a currency war with the BOJ right now and that's the main reason I refuse to even look at the USD/JPY let alone risk a trade on it. Out of all the major world currencies the US dollar and Japanese yen are the two worst of all. Both US and Japanese fundamentals are deplorable and both central banks want their respective currencies to tank, so trying to trade a currency where both the dollar and yen are paired together makes no sense to me right now because there's no clear bias either way, it's literally a battle of the worsts and a race to the bottom.
In the end, it doesn't matter what any chart or indicator might say, until the Fed wants the dollar to stop depreciating or until crude oil falls off a cliff, the euro and pound sterling will stay on course and keep beating the crap out of the dollar, it can't go any other way.
Does the dollar lead crude or does crude lead the dollar?
Ever since I started writing blogs on Forex and on trading I've strongly encouraged EUR/USD traders to use the price of crude oil as a trade indicator because the inverse correlation between crude and the dollar is about as cut and dry as it possibly gets. There's no debate at all that when crude goes up the dollar goes down but what many traders ask me is which market leads and which market follows?
If you listen to most of the analysts and economists they will tell you the weaker dollar leads to higher crude but I do not agree with this assumption at all and there's a very simple reason why -- the dollar is not denominated in crude oil. In my view, the reason why crude leads the dollar is because crude is denominated in the dollar, not the other way around. When crude is bought its is the exact equivalent of selling the dollar.
It doesn't matter what the reasons are that make crude go up all that matters is a higher valuation in crude and an appreciating price of crude will lead the dollar lower because the dollar is denominated in this commodity. A market participant who buys crude is also selling dollars at the same time, but a market participant doesn't have to sell crude to buy a dollar.
Think about the correlation between crude and the dollar the same way that it works with the EUR/USD pair... because of the way the currency market works, the euro is conjoined with the dollar, so when you trade the EUR/USD and you buy it, you are selling dollars against euros and when enough of the market is doing the same, the price of the euro moves higher against the dollar. So when the market buys crude it's selling dollars and the buying of crude is what's leading the dollar lower. It's about as simple a market correlation as it gets.
All the talking heads who think a weak dollar translates into higher crude should probably do some homework to better understand the dollar-denomination correlation to the price and valuation of crude. And I'll renew my encouragement to traders to use crude as it's a true leading indicator, the correlation between crude and the EUR/USD is a beautiful thing.
Friday trading:
Bottomline, do not trade the market tomorrow... if you made a profit this week hang on to your profits and sit on the sidelines because I'm expecting very choppy price action and some volatile price swings. We have key fundamental events out of Europe and the US in addition to a few Trichet speeches and Fed speeches. Plus tomorrow will be the start of the G20 meetings in Berlin and there's no way to predict what kind of market-moving rhetoric and verbal manipulation will come out of the G20 this go around.
Typically the G20 is a worthless do-nothing event but that doesn't mean it will be the same this go around. When you put a couple dozen central bankers and finance ministers together in light of current market and economic conditions there's no telling what kind of stuff they will hit the markets with. I do not trust any of these guys and I would not put it past any of them to make some off-handed comments about currencies, sovereign debt, crude oil or the fundamentals.
The other reason I suggest sitting on the sidelines is due to the typically Friday volatility that comes with major market participants squaring their books for the week. If you took a hit on your trading do not attempt to revenge trade tomorrow, it's not worth it. Let the big boys square their books and let the G20 do their thing.
The euro and especially the pound sterling have made strong gains this week and it would not surprise me to sell a pullback based on profit-taking. Not all participants will want to let their positions run over the weekend and any profit-taking on euro or pound long positions will bring the EUR/USD and GBP/USD lower. The only way I see those pairs being able to move higher tomorrow is if crude and the S&P keep going up, otherwise, they will either range or likely come lower.
If you do trade tomorrow I suggest using half of your normal position size in order to better mitigate risk. Be smart with your risk and money management and have a great weekend.
