After the wild price swings during the late Asian and early European sessions, Wall St. traded mostly under choppy up/down conditions. The S&P 500 and Dow were in the green for a good part of the day mostly thanks to crude remaining well supported, but I think a lot of the choppiness was due to alarming weakness with the financials and a big downside surprise with the housing data.
Today's price action gives pretty clear evidence that market participants continue to look for any piece of news, rhetoric, or geo-political event as an impulse to either buy or sell. The financials on the S&P 500 dropped over 4% keeping the entire index under pressure and capping gains for most of the day. The downside slide on the financials intensified almost immediately after Moody's released a new negative report on the commercial real estate market.
Many are saying the commercial real estate market is the next shoe to drop. I don't know much about that sector but I do not find myself disagreeing with the speculation commercial real estate will take a big hit. So between Moody's report about falling real estate prices and the abysmal housing data, crude was unable to sustain above $60 and the S&P 500 suffered from profit-taking and lack of buying conviction. Housing and building permits worst on record:
There are a few good lessons from today's housing data, and not just about how bad the US housing market is but also a great lesson about market behavior and market psychology... before we get to the trading lesson, lets break down the data. According to the Commerce Department new Housing Starts plunged 13% last month while Building Permits dropped by 3.3% -- both of these are record low prints and clearly show evidence a bottom in housing has not been put in as some analysts have been saying.
Most of the downside attributed to the surprising drop in Housing Starts is the fact that multifamily homes declined to 90K in April after printing at 167K in March. That's a pretty nasty drop and shows there are far fewer subdivisions and apartment complexes going up, and that likely means commercial contractors can't get the loans they need based on the lack of consumer demand in addition to lenders remaining fearful of the commercial credit market.
So what's the lesson? Well, I learned a good lesson today, maybe not so much a lesson but a good reminder... I was personally forecasting a positive print on today's housing data and obviously got it wrong. I don't really trust government data so whenever I do forecasting for a bigger fundamental events I look at other areas and sectors and markets to get clues and signs. Yesterday as I was doing my research for today's fundamentals, and specifically the housing data, I noticed almost all of the big name home builders like Pulte, Centex, and Lennar put in a wildly strong performance, ending the trade day with strong gains.
I was thinking that was a good sign the data might actually print to the upside... reason being, if somebody knew something I didn't know, and they knew the data would surprise to the upside the stock values of those home builders would probably surge, so I correlated yesterday's gains on the home builders as a sign market participants were pre-positioning themselves for today's housing data.
But what I failed to realize and failed to remember was the old mantra that exists not only for the equities market but for all markets -- buy the rumor, sell the fact... I'm not a news trader so the fact I got the forecast wrong didn't hurt me or cost me anything, but had I been a little smarter and savvier in this case I should have known the big market movers were buying the rumor so they could sell the fact and recognizing that I at least could have produced a better forecast.
When we're in a trading environment where market participants react to the daily news events I think it's important for us to be mindful of the psychology and gamesmanship that goes on before and after these news releases. In this scenario we have a very clear example of what it means to buy the rumor and sell the fact, but these types of moves go on every day in the markets, and especially in the FX market.
And speaking of buy the rumor, sell the fact... UK inflation data slows pound sterling appreciation:
If you took my advice to watch the market during this morning's inflation event you would have observed the GBP/USD and GBP/JPY run up like gangbusters from the moment Europe opened and right until the UK inflation data was released at 0430 EST. Unfortunately for any traders that were buying the rumor at the top got hit hard by the worst inflation print in the past 15-months and the worst retail inflation data in the past 41-years.
As the inflation data hit the news wires, the GBP/JPY went as far as it could possibly go, making a top at 149.62, and then did a 180-degree turn, never looking back and falling as far as the 148.05 level within just 5.5 hours. The GBP/USD didn't take quite an immediate hit and continued to test up at those levels but never had the fire power to continue higher and finally gave way and made its lows as the sterling-yen was make its low.
Why didn't the pound take nearly the beating the euro, dollar, and yen does on negative inflation data? I think there are a few reasons... first of all, although there is a definite disinflationary environment in the UK, it's not nearly as bad and protracted as what's happening in the Euro area or in the US. UK CPI is at 2.3% which is actually above the BOE's target rate of 2.00% and Core CPI is only 0.5% below the 2.00% level.
So there's surely disinflation happening in the UK as the prices of food, energy, and wages are continuing lower but it's not as dire a situation as in other parts of the industrialized world. As bad as the fundamentals are in the UK, they still have some minor inflationary pressures going for them and this is supportive of the pound against the majors. If the inflation situation continues to go south on the UK that's when the pound would come under greater pressure than what we saw today.
I still believe inflation data continues to be some of the most key fundamentals right now and data the big market movers are watching closely and reacting to. And speaking of inflation, Australia has an inflation-related data release tonight at 2130 EST...
For tomorrow's trading, crude oil, along with the S&P 500, will remain the center of the universe. Crude made another multi-month high today but once again failed to sustain a break above the key $60 level. I'm going to forecast that crude does end up breaking the $60 level and we could see it happen any time between now and tomorrow's trading. Barring an equities sell-off I believe the market will make another run at $60 and bust through.
Sure enough, just as crude lost some momentum yesterday another "fire" broke out a refinery in Texas and you know what happens... it means prices go up as participants react to this news event. Crude and the S&P 500 both need each other right now like two co-dependent crackheads. Is there any fundamental justification for crude to be up at these levels? Of course not, but fundamentals are no match for risk-hungry market participants who believe the quickest path to gains is buying crude, for whatever reason.
The first big fundamental event is actually at 1950 EST this evening when Japan releases their latest GDP data, so keep an eye on the Forex market for some heightened volatility between 2000 EST and 2230 EST this evening... you may find a good trading opportunity or at least something fun to watch. The Japanese Prelim GDP printed at -4.2% but the really bad part was the inflationary comoponent to their GDP which printed 1.1% and this is very JPY negative. Euro fundamentals--
Out of the Eurozone the big data on Wednesday of course is PPI. I expect PPI to recover slightly and not make a lower print than the prior month but should we get a downside surprise here, the euro could easily come lower, especially if PPI prints at -0.8% or worse. Dollar fundamentals--
Little Timmy Geithner has a speech at 0930 on Wednesday, so be on the lookout for that. The two biggest data events are Crude Inventories and the FOMC Meeting Minutes. For some reason I believe Crude Inventories will be crude+. The FOMC Minutes shouldn't be too big of a deal, I don't expect anything shocking, if there is any shocking rhetoric it will be to the benefit of Wall St. and against the dollar.
As far as trading goes, I'm sticking to the same plan which following crude and the S&P 500, and that means buying the euro and pound against the dollar and yen on the dips when I get a good probability trade. I'm not opposed to shorting on the rises but I would need a very high probability price action pattern to risk on the short side, I think there's less risk going on long until the market sentiment changes and risk appetite subsides.
For all the CAD traders don't forget you have inflation data to contend with tomorrow at 0700 EST. That's all for now. Be smart with your risk and money management. Key levels will be posted in the morning.
Market rally led by crude's 6-month high and S&P 500 gains:
Today's monster rally was led by exactly what we talked about in yesterday's weekly outlook... crude oil and the S&P 500. Crude put in it's best performance in 6-month's leading the S&P 500 and all US equity markets to strong upside gains and taking the higher-risk/higher-yielding currencies right up with them while sending the US dollar and Japanese yen to the depths. Spot crude started Sunday by moving decisively off its lows around the $56 level and skyrocketing well above the $59 level.
After crude got the party started the S&P 500 futures rose up from the ashes around the 875 level and never really looked back, going all the way to the 908 level by the time Wall St. closed this afternoon. When it was all said and done the S&P 500 cash market gained 3% on the day and the Dow gained almost as much.
The euro, pound sterling, dollar, and yen started Sunday where they left off on Friday but as soon as their correlated markets decided to go on a rampage the dollar and yen didn't stand a chance to gain any more ground on their higher-yielding counterparts.
I'll repeat what I said yesterday -- it's all about crude right now... so goes crude, so goes the markets...
Why did crude gain 5% today?
Today's 5% gain was fueled purely by geo-political reasons. Market participants are looking for any and every reason to either buy or sell and just a few hours after we opened for trading yesterday the reasons to buy crude kept piling up which correlates to plenty of reasons to sell the dollar and yen... I'm sure my opinions on this will be shared by just about everybody else out there, but no matter, this is purely geo-political stuff going on that have nothing to do with demand or pretty colored lines on a chart...
1. The world's largest democracy, India, sent a strong message against communism and elected a more free-market style legislature. In return India's benchmark equity market called the BSE Sensex surged by 17.34%. When an emerging market like India puts in this kind of performance coupled with a democratic victory in their legislature, crude almost has to go up as this is a great sign for emerging markets.
2. Nigerian crude pipelines were sabotaged by rebels in addition to them threatening to prohibit shipments of crude out of the Nigerian delta. You remember last spring and summer when crude started making its historic descent? If you do then you probably remember that every time crude dropped a few bucks, like it did last Friday, all of the sudden Nigerian rebels started attacking pipelines.
Surprise, surprise... the same exact thing is happening again at the same exact time of year. I highly doubt this is a coincidence. The main reason Nigeria is such a geo-political hotbed in relation to crude is because Nigeria produces the good stuff, the light sweet crude and that's exactly what I watch to determine direction of the S&P 500, USD, EUR, GBP, etc. That's why this particular geo-political issue is of such importance to trading.
3. The largest crude refiner in the North had a big explosion yesterday afternoon and operations were halted. The explosion was at a Sunoco plant which produces 175K barrels of oil a day.
So, even though the fundamentals are against crude being able to gain, the fundamentals are no match for geo-politics and there's been nothing but geo-politics the past 24-hours that are very supportive of crude. If I didn't think crude wasn't the center of the universe right now I wouldn't have been so long winded about it yesterday and like I'm doing now... Mega fundamentals for GBP, EUR, and USD:
For those who trade the GBP/USD, GBP/JPY, GBP/CHF or any other variation that involves the pound sterling you will absolutely want to be in front of your trade station when the latest UK CPI, Core CPI, and RPI data hits the markets at 0430 EST on Tuesday. I'm not expecting a big downside surprise with the UK's consumer inflation, but should we see something shocking like a print below 2.00%, the pound should come under considerable downside pressure. Conversely, a hotter than expected print would give market participants even more confidence to continue buying the pound against the dollar, yen, and the others. Inflation data remains critical to currencies...
As for the euro, we get the important German and Eurozone ZEW data. I believe we'll see a print as expected with a decent probability to see a better than forecasted print. With the ECB moving their key lending rate to 1.00% in addition to announcing a plan to further stimulate the economy, plus the recent trend of surprisingly good US data, I think the ZEW index will continue moving positive. The historical average for ZEW is 26.1 so if we get a major upside surprise and see a print at 26.1 or better, the euro would benefit mightily against the dollar on this news.
The big US data tomorrow is obviously Housing Starts and Building Permits. I forecast improvements in both sectors and on both pieces of data. I think it's interesting that the big-name home builders such as Pulte, Centex, and Lennar all put in an extremely strong performance a day before the housing data is due to be released. So based on recent trends with the housing data and what we saw on Wall St. today, I'm not expecting any downside surprises here.
For Tuesday's trading it should be fairly cut and dry just like it was today -- good fundamentals, no downside surprises with the inflation data, and a continued upswing with crude will keep the USD and JPY pressured against the high-yielding currencies. Crude will remain the linchpin that will either hold all the markets together or send them unraveling.
I really don't have much more to add, it's not rocket science here... I'll be taking my cue from the correlated markets and at this point remain more biased and comfortable to buy the dips and sell the dollar and yen against the majors. The ECB continues to talk up the euro, so we don't have any change in verbal manipulation in this regard. Keep your eye on that UK inflation data and of course the market correlated variables to help give trading direction.
For the week ahead, at least at the very start, the attention of market participants will be squarely on Wall St., namely the S&P 500 and crude oil. I believe those two markets, along with their correlation to the US dollar Index, will sway market sentiment, drive money flows, and set risk appetite.
The reason I took all bets off equities at the start of May become obvious as Wall St. put in their worst performance in the past 10-weeks... the S&P 500 ended the week by losing 5% while the Dow lost almost 4%. The European bourses were not immune from a sell-off either after Eurozone GDP and inflation data disappointed to the downside leading to heightened risk aversion.
From a pure price action and market psychology standpoint, I think we saw Wall St. do what all markets do -- reverse on all the traders and participants who pile into the last 5% of a market move, buying into the over-extension that is never sustainable and leads to a reversal. As is always the case when equities drop, the dollar and yen become prime beneficiaries. Last week the JPY gained almost 4.5% on the EUR, the NZD lost 3% to the USD while gaining 1% on the EUR to name a few.
For most of the week the euro was supported by the ECB talking it up against the dollar but eventually fell to the dollar for purely fundamental reasons in addition to central bank intervention which we'll cover next...
I think this trade week will start on the same footing we left things on Friday, but the key will be to take things one day at a time as market participants are reacting to every piece of data, rhetoric, and geo-political event. In other words, this is still very much a traders market and you should expect the Forex, equities, commodities, and securities markets to be choppy, volatile, but remain tightly correlated to the S&P 500, crude oil, and the US dollar Index.
"Just watch out because the SNB and any other central bank can use the element of surprise to hit the markets when they least expect it and the temporary effect of an open-market currency operation can be brutal for those who are caught on the wrong side."
That became a reality last Friday afternoon as the SNB coordinated with the Bank of International Settlements to sell the Swiss franc against the euro and dollar in order to halt the franc's seemingly unstoppable appreciation. The SNB and BIS used the element of surprise beautifully, they waited all week long and timed their open-market operations perfectly knowing how ill-liquid the markets are on Friday and how easy it is to achieve their agenda. The open-market operations against the franc are mostly meant to keep the EUR/CHF above the 1.5000 level and the USD/CHF above the 1.0900 level.
Those types of open-market operations are rarely effective over the longer-term because even central banks like the SNB and BIS cannot fight the war against the collective buying power that exists in the FX market nor can they fight against the natural order of price action that occurs when the S&P 500 and US dollar Index make their respective moves. I'll repeat my warning -- we haven't seen the last of these central bank interventions and the banks will intervene when opportunity presents itself, capitalizing perfectly on the element of surprise.
Watch crude oil:
In my opinion crude oil is the real linchpin for this week's trading and for what kind of risk appetite participants will have... last week crude lost 4% mostly due to poor inflation and growth data out of China, America, and Europe. The negative data releases also coincided with crude testing the key $60 level and failing to break. Fundamentally, this week is no different for crude as we get another good haul of inflation, growth, housing, and building data out of Asia, the UK, and the US. Crude will get its first big test on Tuesday as we get UK inflation data, then US Housing Starts and Building Permits followed by Japan's Preliminary GDP later in the evening.
The price at the pump for gasoline has been rapidly rising in the US. In just the past three weeks prices are up 25-cents on average, marking the biggest week-on-week rise in more than 12-months. What's helping drive prices higher is thanks to a sharp drop with supply and cutbacks with production. US crude refiners are only operating at 84% capacity currently. While this help drives crude prices higher and gives speculators confidence, consumers are beginning to pullback on their demand... consumer demand for gasoline fell by 12,000 barrels in just a week and is down 1.2% year-over-year.
Who is going to win? Wall St. or Main St.? Wall St. needs crude to continue higher in order to push the S&P 500 back up but the consumer will need crude lower in order to bring demand back up. The juxtaposition between Wall St.'s needs and Main St.'s needs are setting up for a nice battle in the short-term, so keep your eye on spot crude and crude futures this week because I think the market will look for direction based on how crude is trading and how well it holds up against possible downside surprises with key fundamentals.
It's all about crude... Euro fundamentals and the ECB:
On a fundamental basis, the week ahead is once again critical for the Eurozone. In addition to all the data which will sway market participants we should expect the ECB to keep a steady flow of rhetoric hitting the markets every day this week. Prior to the ECB's rate decision there was quite a bit of dissension among ECB Governing Council members on the future of interest rates, but last week most ECB's were all of one accord.
I do not think the ECB can be trusted right now as they are clearly using rhetoric to impact the price of the euro vs. the dollar. Just because the ECB was talking the euro up last week doesn't mean they won't talk it down this week. It's important to remember the Eurozone has an even bigger banking crisis than the US and especially Asia. European banks are more leveraged and have a vast debt burden to contend with. This puts the ECB and European banks in a very precarious position.
Fundamentally and geo-politically, the ECB is stuck between a rock and hard place in terms of the best euro valuation... if they want to deal with Europe's debt and over-leveraging issues they will need a strong euro as a strong euro will act as 'equity' and equity is desperately needed by Eurozone banks. On the other hand, the fundamental situation with German exports, for example, will require a very weak euro against the dollar. Germany is the lifeblood of the Eurozone economy and exports are the lifeblood of Germany and there's been a whole lot of bleeding so far this year.
In Q1 German GDP dropped by a staggering 3.8% and was the worst contraction since record keeping for this data began 39-years ago. Europe's economic recovery hinges on Germany in my opinion. Take a small European economy like Latvia... their GDP dropped by 18%! Western Europe has to turnaround before Eastern Europe can even have a fighting chance, but this can't fully be accomplished with a surging euro. The ECB is smart enough to realize how they markets work... if crude and the S&P 500 are going up they know the euro will go up in tandem. So, I don't think it was any coincidence the ECB talked the euro up last week as they saw equities and crude moving lower. That could be a sign the debt and over-leveraging issue carries more weight at the moment, but after last week's abysmal GDP data this could certainly change, especially if the Bundesbank pressures the ECB on the stronger euro. Economic calendar:
For the EUR/USD these are the fundamental events I'll be most focused on:
ECB Weber speech (Monday 0500 EST) Eurozone Trade Balance (Monday 0500 EST) Treasury Geithner speech (Monday 1130 EST) German and Eurozone ZEW (Tuesday 0500 EST) US Housing Starts and Building Permits (Tuesday 0830 EST) German PPI (Wednesday 0200 EST) Treasury Geithner Speech (Wednesday 0930 EST) Crude Inventories (Wednesday 1030 EST) FOMC Meeting Minutes (Wednesday 1400 EST) German Manufacturing and Services PMI (Thursday 0330 EST) Eurozone Manufacturing and Services PMI (Thursday 0400 EST) Initial Claims (Thursday 0830 EST) Bernanke Speech (Friday 1400 EST)
Other big fundamental and geo-political events include inflation, retail sales, and growth data out of the UK, growth data out of Japan, and a BOJ interest rate event. Wall St. may have to deal with a GM bankruptcy announcement this week in addition to key earnings reports from mega retailers like Home Depot and Lowes which could be used to gauge the health of the US consumer. It should also be noted that the ECB governing council has a meeting in Frankfurt on 20-May starting at 0300 EST. Be on the lookout for any possible ECB rhetoric after the meeting convenes.
As far as trading goes I'm taking this market purely on a 30-minute by 30-minute basis. The volatility we saw last week produced at least two solid tradable price action patterns per day on the EUR/USD, EUR/JPY, and GBP/JPY both on the long and short side and I expect to see much of the same this week. The markets are looking for any and every reason to make a move, whether it be a piece of news, central bank rhetoric, or surprise geo-political events. So my personal trading plan will be to allow the market to do its thing, not get married to either side of the market, and play the price action patterns. I'm not a bull or bear this week but an opportunist.
Be advised of the higher probability for stronger price swings once Frankfurt and London opens this morning... don't forget they missed the moves on Friday afternoon when the S&P 500 and crude oil melted down in addition to the central bank intervention against the Swiss franc. This means participants in western Europe will likely need to do some additional book squaring or re-positioning and this will lead to times of potential strong volatility.
I will not likely take a trade until I give London a few hours to get their heads screwed back on and settled in. As always, all traders should use smart risk and money management. If market conditions allow I will do a live audio Q and A in the chat on Monday at 1000 EST. Key levels will be posted before Wall St. opens tomorrow.
Lastly, for those traders who are always on the lookout for good resources on a wide range of economic, fundamental, and geo-political issues facing the markets I would like to recommend a great blog packed with tons of resources for all walks of life and schools of thought... you can check it out here.
After equities, commodities, and the high-yielding currencies came under selling pressure yesterday, an upside surprise with today's Producer Price Index turned the market's right around. At 0830 EST this morning PPI printed up 0.3% month-over-month putting to rest deflation fears for at least today's trading...
In case you might be skeptical or unconvinced how critical inflation/deflation is right now to the markets all you need to do is pull up a chart for the EUR/USD, EUR/JPY, GBP/USD, GBP/JPY, spot crude (cl_cont), and the S&P 500 futures (es_cont) and you can clearly see every single one of those inflation-sensitive, higher-risk, higher-yielding markets made their turn upwards within minutes of the PPI data hitting the market. Not only did they make their turn after market participants had a few minutes to digest the data, but they never looked back until they all exhausted themselves at the 1530 EST time frame.
It's no coincidence those markets made their bottom for the day, turned back up and rallied within minutes after the PPI data hit the news wires because each and every one of those markets need price inflation and rising price pressures in order to keep moving higher. And within 30-minutes of the PPI data release the US dollar Index topped put and did nothing but fall, along with the Japanese yen. Psychology behind inflation and price action--
Now that's all well and good, but what's the practical application and lesson for us traders? There are several lessons, especially for any traders who tried to buy the dollar or yen against the majors and crosses for lack of understanding how the underlying fundamentals of the markets drive price action.
The main lesson has to do with sentiment, specifically, how inflation data drives market sentiment which drive money-flows... it's a pretty simple correlation and it goes like this:
1. Higher prices for finished goods leads to: 2. Higher usage of commodities to produce finished goods which leads to: 3. Higher prices for commodities based on higher demand and usage which leads to: 4. Producers passing their higher costs to the end user which leads to: 5. Higher consumer inflation
Think about it this way... when you combine the factors of a product costing more to produce and being in higher demand, the price has to go up and when more finished goods are being produced it also means the costs of those commodities used to produce and bring to market also go up accordingly, if all of those prices are going up they will get passed on to the consumer.
So that means CPI could go up and when CPI and PPI both go up, commodities go up, and when commodities go up, equities go up. When the prices of both commodities and equities go up, higher-risk and higher-yielding currencies like the EUR, GBP, and AUD all go up. Wall St. needs inflation, bottomline. What's good for Wall St. is good for the EUR/USD and its higher-yielding comrades and bad for the USD.
That's the psychology behind the fundamental factors for how good inflation data would cause bullish sentiment and positively effect money-flows into markets that offer the promise of better yields and higher returns in the future. Now, today was about as beautiful an example as we've seen in awhile for how good inflation data can cause a market rally, it doesn't always work so smoothly and succinctly, but I think it's important for traders to have a good fundamental understanding for how this all works. When the big money movers look at data like PPI, that's what they are thinking and their thinking leads to stronger risk appetites and a healthier demand for better yields.
ECB remains hawkish on rates, supporting euro:
Besides the good inflation data, the EUR/USD was also pushed higher by more hawkish rhetoric out of the ECB today. It was basically a non-stop cavalcade of hawkish comments on interest rates. Besides the equities rally boosting the euro, the dollar really didn't stand a chance against the euro today with comments like this:
ECB Orphanides: "Current ECB rates appropriate" ECB Stark:"Interest rate is adequate" ECB Sramko:"No decision on lower bound to interest rates" ECB Nowotny: "Not discussing changing rates"
In addition to hawkish rhetoric on interest rates, at least a half dozen ECB's downplayed any possible deflation and disinflation. I'm really not sure why the ECB is trying to talk up the euro so much, the only thing I can image is that maybe they want the euro higher to better manage the deleveraging process and debt re-payment process, but a strong euro certainly won't help the German recession rebound and their plunging exports to recover.
Regardless, as long as the ECB keeps talking hawkish on inflation, interest rates, and a rebound in growth, it's a pretty risky move to bet against the euro and this is one of the main reasons I've not removed my bias to buy the euro against the dollar on the dips and to stay out of dollar-long positions. I don't see the point in fighting for the wrong side until the tide changes... even though the ECB might be a little delusional right now, they control market sentiment and money-flows by their own rhetoric. Friday trading:
We have another big fundamental day tomorrow with everything from growth, inflation, manufacturing, production, and consumer data for the Eurozone and US starting at 0200 EST and pretty much straight through to 0955 EST.
At this point on a Thursday after trading all week I'm not even going to bother burning any more brain cells trying to research or forecast tomorrow's data. With all the book squaring, profit-taking, and loss-taking that goes on every Friday, you can expect some times of chaotic price action and sharp price swings. Plus the data flow is only going to further add to the insanity. The best advice I can give to traders is to be happy with this week's profit and sit on the sidelines tomorrow, that's probably where I'll be. Sometimes the smartest trade is no trade at all...
If you do trade tomorrow consider taking half your normal entry size and be smart with your risk and money management. Key levels will be posted in the morning.
I won't have time this evening to do a market update, I apologize for that. But in the time that I do have I wanted to answer a question a trader emailed me early this morning. He was asking about what may have caused the sharp drop in the pound sterling, specifically on the GBP/USD and GBP/JPY.
As you know the pound has been fairly strong against the dollar along with the euro. The main contributing factor to the pound and euro's strength against the dollar of course has just about everything to do with gains on the Dow, S&P 500, and S&P 500 futures in addition to the upside in crude oil and gold. All of those factors are very supportive of the higher-yielding currencies and lead to the US dollar Index falling lower. But this morning the GBP was sold-off violently against the dollar unlike we've seen in recent days and there's a perfect reason why and the only reason why...
At 0530 EST this morning BOE King delivered a worst-case-scenario message for the GBP... he told the markets the BOE was now expecting lower growth and even lower than forecasted inflation. Rhetoric like that out of a central bank, especially about inflation, is pretty much the death knell for that central bank's respective currency, and such was the case with the pound sterling today.
The last rhetoric we heard out of the UK's Chancellor was that he was expecting better growth and inflation that was near the BOE's 2.00% target. But this morning BOE's King contradicted Darling's forecast and hinted at the dreaded disinflation that is quite clear and obvious at this point. So, after King's negative comments on growth and inflation hit the news wires the GBP/USD dropped over 220-points and the GBP/JPY took top to bottom plunge of almost 300-points in today's trading.
There's really not much more to say on this one, it's cut and dry stuff... any rhetoric like this out of a central banker, especially when it comes to disinflation, is going to rock the FX market.
Here are the comments that sent the pound lower:
"The risks are weighted toward a relatively slow and protracted recovery; there are pretty solid reasons to question whether a recovery can be sustained" "At home Bank Rate has fallen almost to zero, there has been a fiscal stimulus and hundreds of billions of pounds have been directed to supporting and resolving the banking system. Now the economy requires a period of healing. That will take time"
And this gem really put a hurting on the pound:
"Inflation is more likely to be below the target than above"
Overall, the dollar and yen had a strong day based on the sell-off of equities and retail sales data that disappointed to the downside. As I posted in the chat, I took my first EUR/USD short in almost two-weeks and this was based purely on the EUR/Equities correlation that was pressuring the euro lower. That 1.3568 downside key level acted as strong support today, it was tested three times and failed to break but I would expect the market to take another run at it if the S&P 500 futures and spot crude continue their slide.
If you're trading stay alert during Tokyo because we could see some good volatility and price swings, especially around the 1900 EST to 2030 EST time frame and then again between 0000 EST and 0300 EST. Be smart with your risk and money management as tomorrow is another big fundamental day with key inflation data out of Switzerland and the US, a speech by SNB's Jordan, various rhetoric out of the ECB who continue to be hawkish, and then of course Initial Claims.
Today's update will be a little different, instead of the normal stuff we're going to solely focus on trading, price action, and price action patterns.
Trading repeated price action patterns:
The topic of price patterns and probabilities came up in our chat today and a few traders asked me to expand on what I was saying and explaining. I want to use today's update to cover some actual aspects of trading and trading techniques that I use, specifically the price pattern aspect. Time and space will not allow me to get too in-depth on this stuff but I want to cover some of the basics here for the benefit of those traders who really want to learn for themselves.
On a trade day like today with the various ECB rhetoric, better than expected Eurozone and UK data, and then the plunge on Wall St., the Forex market ran wild from as soon as London opened right through the mid-afternoon NY session. The beautiful thing about today was the irrationality and emotions of market participants contributed to a strong degree of volatility and larger price swings which allowed for several tradeable price actions to form.
Before we cover an actual price action pattern that played out today and that was used for trading, I want to lay the ground work by explaining a few personal theories and philosophies on price action, patterns, and how they all connect together.
The term price action has been growing in popularity in the trading world in recent months and everybody seems to have their own definition and application for the term. In my view price action is not an activity but a cause-and-effect event that occurs in the market at any given moment, and this cause-and-effect event is just the sum of its individual components. These components are:
Path of least and or most resistance
Combine all six of those components and what you get is an event which enables price to change, move, and flow at any given moment, in any given direction and at any given time. When I'm trading and watching the price action what I am really doing is using those six components to deconstruct the changes, movements, and flow of price in order to help me formulate an opinion to make a trading decision in the future.
What sets this cause-and-effect event into motion are humans and their emotions. You, I, and millions of others just like us are the ones responsible to set the event of price action into motion at any given moment of the trade day. As long as a living, breathing, and feeling human being has access to the buy and sell button, the price action event will occur to one degree or another. To the degree at which this event occurs, price action will then define itself by the velocity, momentum, speed, direction, and path of least/most resistance, set in motion by the collective buying or selling power of humans who are ultimately driven to make decisions based on two things:
The opportunity for gain
The fear of loss
Price action and price fluctuations--
Price is never wrong and price is the only honesty you will ever get in this market because the market itself is never wrong, it cannot be wrong. If the market says the price of the EUR/USD at 1.3594 is too low, is a good value, and should be valued and priced higher, a larger degree of the market will attempt to buy the euro at 1.3594 than what supply would be available to buy at that exact moment in time. More humans believe they can gain by purchasing the euro at that price as opposed to the amount of humans who fear the risk of loss. Conversely, there may be almost just as many humans who believe they can gain by selling the euro at the price of 1.3594. Both sides might be correct, but only the future holds the answer to that question and this is where the two emotions of fear and greed control the decision making once the trade has been made and must be managed by the human who decided to participate at the price of 1.3594.
When the supply of available contracts at the price of 1.3594 cannot meet the demand of bidders who want to buy the available supply at 1.3594, the price changes, it goes up and forces those who wanted it at 1.3594 but didn't get it at 1.3594 to pay more to get what they want. As long as more humans demand to buy the euro than there is supply at any given price, price will have to go higher, it cannot work any other way. Now this doesn't mean those humans who thought the dollar was a better value when the euro was at the price of 1.3594 are ultimately wrong, it just means there were more humans who wanted something that was in greater demand but had lesser supply at that given moment in time.
So everything we've discussed thus far is what leads up to how tradeable price action patterns develop and are formed. One of my philosophies on price action says that the price of any market, including currencies, will always over-extend and over-exhaust itself to the upside or downside. How this applies specifically to the spot Forex market stems from my belief that a larger degree of retail traders will buy or sell into the final 5% of a market move. The bulk of the buying power that propelled price from the "lift-off" point has either stopped buying or has begun the profit-taking process. Therefore, the demand is lacking to force price higher and lack of demand is one of the main contributing factors leading to price failing to continue higher or lower.
Those market participants who pile into the last 5% of a market move lead price to exhaust itself in addition to the contributing factor of stop loss triggering. When you combine exhausted price and the effect of stop loss triggering, you get an over-extended price that will struggle and then ultimately fail to move beyond a certain point at that given moment in time. Then comes the addition of market participants who believe price is over-valued and the collective buying power of this group of participants contributes to price failing to continue and price will falter and begin to reverse.
Price action pattern formation--
Here's where another personal philosophy of trading comes into play... I do not believe price action in the currency market actually goes up and down, rather I believe it just goes in a continuous circle. I think the way price is displayed on a candle or bar chart is completely wrong and inaccurate because on a chart price is displayed as moving in an up and down motion which gives the false idea that price has a true starting and stopping point, a top or bottom, or a beginning and ending point.
I believe the price of a currency has no top, bottom, beginning, or end. If a currency did have those things that would mean there's a starting and ending point, a place where price could ultimately be unable to increase or decline in value; a final resting place. There cannot be an absolute price for any currency purely on the nature of how they are paired together. There is no such thing as a single currency that stands alone, so there cannot be an absolute price because each currency is valued against another.
Just because the EUR/USD went to 1.6048 last July and has not returned there since does not mean the EUR/USD will never go to 1.6049 and beyond. Price is continuously in a state of repeated replication. During today's trading the EUR/USD hovered roughly between the 1.3550 and 1.3700 level. In 2008 at a certain moment in time it hovered at the same exact levels. In 2007 at a certain point in time it hovered at the same exact levels.
In other words, price has completed a circle of replication and this is exactly where I find price action patterns that have been repeated in the past. Pattern recognition is nothing more than observing the past, analyzing the data from the past, and connecting the past to the present to get a probability on the future when price is in the replication process.
I'm running out of space to continue this commentary but hopefully this gives you some more insight to how I utilize this aspect of trading. I want to finish up by giving you a beautiful price action pattern for the GBP/JPY that formed this morning. This pattern formed today, it's formed in the past, and based on what the market did every time this exact pattern sequence formed, I was able to make a trading decision with a probability, knowing exactly what to expect because price had replicated itself which gave me a look into the future... GBP/JPY price action pattern--
As you know my strategy with price action says when the GBP/JPY completes a pattern sequence of at least seven consecutive higher opens or lower opens over seven consecutive 30-minute time frames, there is a high probability the market has exhausted and over-extended itself and I will then play the market against itself, against all those traders who do not understand these concepts and will pile into the last 5% of the market's move which puts them on the wrong side of the market, ultimately either stopping them out or causing them to take a loss.
Here's the pattern sequence:
0300 EST - 4718 pip differential of +37
0330 EST - 4773 pip differential of +55
0400 EST - 4840 pip differential of +67
0430 EST - 4862 pip differential of +22
0500 EST - 4887 pip differential of +25
0530 EST - 4905 pip differential of +18
0600 EST - 4920 pip differential of +15
So here we have seven consecutive higher opens and based on this pattern sequence, my trading strategy called for me to take a GBP/JPY short position at the price of the seventh higher open which was 149.20 targeting no less than 80-pips profit. The GJ's high of the day was around 149.48 if I recall, so what my strategy was showing me the market has exhausted and over-extended by the 0600 EST time frame and any move in price beyond the 149.20 level would only up the probability of a reversal, not a continuation because price would only further exhaust itself.
By 0736 EST the price pattern paid the 80-pips profit and should the trade have been held longer it would have been paid in excess of 250-pips from entry to the low price of the trade day. That pattern sequence above has formed in the past and it will form again in the future because the market will complete the circle of price replication again in the future and when it does, I will get the same exact results unless an unforeseen geo-political event occurs to alter the emotions of humans and their decision making. But even if I did not know this was a replicated price pattern, just based on the sequence and the pip differentials alone I would know it's time to short, not to buy... but the geo-political factor is a whole other aspect of price action we'll need to save for another time.
That's all the time and space I have for now. Don't forget tomorrow is a huge fundamental day and I expect more volatility and price swings in the market. Key levels will be posted in the morning before Wall St. opens. If you have any questions based on this commentary feel free to ask, whether in the chat or via email, I'm glad to help if I can.
Disinflation in the new 'Holy Land' opens markets on negative tone:
After the markets went gangbusters last Thursday and Friday they all took a collective breather today. The markets got off to a rough start on Sunday and all signs started pointing to a down day for equities, commodities, and higher-risk currencies like the euro, pound sterling, and Aussie dollar. What was the first sign? China...
The latest inflation data out of China was not pretty and came as an unexpected surprise to market participants. Don't forget, China has been hailed as the next Messiah who will save the global economic markets and that means more participants are watching and scrutinizing China's economic fundamentals much more so than in the past, including yours truly. I would almost never pay attention to China but now that the markets are putting their hope and faith in China to help revive the markets, I think it's important to watch some of their key data.
As you know I'm all about inflation data right now because inflation is one of the only true catalysts that will drive these markets higher. Any signs of disinflation, especially in China, will not make the markets happy. Chinese CPI printed down 1.5% month-over-month while PPI print down a scary 6.6% month-over-month. Chinese CPI has dropped for three straight months while PPI was the worst print in the last 10-years of record keeping for this data out of China.
The response from this data was felt across the board last night as the Shanghai Composite closed down 1.8% and the S&P 500 futures, Dow futures, and crude sold-off all through the Asian trading session while the JPY gained some ground back. And there's plenty more inflation data for the markets to play with the rest of this week...
S&P 500 and Treasuries:
Both the S&P and Treasuries were most responsible putting downside pressure on the markets today. Without any surprising and happy economic news for Wall St. to get euphoric over market participants decided the S&P 500 was a little too high and now was a great time to lock-in profits and take some risk off the table.
The S&P 500 was trading at 4-month highs before losing 2.2% today and the Dow lost almost 2% after suffering from its own round of profit-taking and risk aversion. While participants were booking profits on the equities markets, money-flows were going into Treasuries as we saw the benchmark 10-year yield drop a hefty 12bps. Between the sell-off on Wall St., Treasuries making a bullish move, and with crude falling almost 1%, the EUR/USD stood no chance of sustaining a move and holding above the 1.3600 level during NY trading.
Bearish Treasuries hurting economic recovery:
The Treasury is going on a two-week hiatus from their auctions, they won't resume again until 26-May, so it will be interesting to see what kind of demand there is from market participants for either Treasuries or equities as we get closer to the end of the month and summer session trading. The Treasury and Wall St. would both like to see Treasury yields start moving back to the downside and prices move up because as the 10-year yield continues moving higher it actually pushes the costs of mortgage lending higher.
When the 10-year Treasury went strongly bearish the past few weeks it pushed the yield of the 30-year fixed mortgage to almost 5.00% and that is a terrible thing during a recession and for a battered housing market. In fact, home equity and car loans have all seen their interest rates rise along with Treasury yields and the Fed will need to rectify this situation and the only way to do it is step up Treasury purchases.
When the Fed first announce they were going to buy $300 billion worth of Treasuries I think most of us knew their program would expand far beyond that and now it's becoming apparent the Treasury will have to print more money to give to the Fed so that the Treasury can create more debt so that the Fed can take the money printed by the Treasury to buy more of the Treasury's debt... yes, it's a convoluted scam but that's the way it works and I think more dollars will need to be printed and more debt will need to be monetized by the government to push rates lower across the board. Obama spending spree:
According to the latest numbers from the federal budget office, the national deficit will rise to at least $1.8 trillion. And here's the really nasty part -- the deficit-to-GDP ratio will surge to almost 13%! Basically for every $1 the government spends to keep operating it will need to borrow 50-cents... talk about a shortfall and a scary situation for the economy. I thought George Bush was a reckless spending pig but this stuff goes beyond anything that's even remotely sustainable in light of a GDP that is shrinking, not expanding, and an employment market that continues to shed over a half-million jobs per month.
In the past congress would freak out if the deficit-to-GDP ratio got anywhere above 3.5%, so I imagine there will be quite a battle in DC over the Obama administration's budget proposal and runaway spending plan. From a purely fundamental standpoint this budget and deficit add even more longer-term risk for the USD and for Wall St. The reason a budget like this puts risk on Wall St. is because Wall St. and higher-net worth individuals will be the ones saddled with paying higher taxes to help foot the bill.
Just today Obama proposed $58 billion in new taxes directly aimed at participants in the financial markets and that $58 billion is on top of an existing proposal to raise $1 trillion in new taxes over the next 10-years. To my knowledge there's never been a time in US history when a sharp increase in taxes has helped Wall St. or those higher-net worth individuals who contribute to the consumerism aspect of what actually makes the US economy run and grow. Tuesday trading:
Monday was a quiet news day and Tuesday's not really much busier but we do get some key fundamentals worth noting. The first will be German Final CPI and the Wholesale Price Index, which are both inflationary reports. I'm not expecting any big downside surprises here but I'll keep my eye on those two reports just in case. Should we get a larger negative print on that data I would expect the euro to come under some pressure after London gets rolling on Tuesday.
The big data out of the US is the latest Trade Balance report. We've seen the Trade Balance continue to close what was once a very wide gap. In other words, the US used to have this thing called a 'consumer' and now we do not, therefore, America's trade gap has closed sharply with economies like China, Japan, Mexico, and Canada who are strongly reliant on the US consumer. The best case scenario for the markets would be to see the US Trade Balance print worse than expected, but only if the worse part is due to the fact more US consumers stepped up their buying from those other economies who rely on American consumerism. That would be a good sign of overall recovery for global economic trade and potential future growth. The markets would like to see the US consumer revive, borrow, and spend. I'll be closely scrutinizing the data tomorrow.
In light of a strong sell-off on the S&P 500 today, spot crude managed to move back above the $58.50 level which helped keep the euro fairly supported against the dollar. For those traders who were expecting to see a massive euro sell-off after Friday's mega run were disappointed and probably got stopped out yet again. I've not changed my personal trading bias and I will not buy the USD against any of the majors.
The USD Index gained back a little ground but nothing to get too excited over and I still believe the dollar remains at risk, especially if the S&P 500 can hang on to its gains and keep pressing northbound. That being said, as we talked about this morning during the Q and A session, I still believe the closer we get to summer session trading conditions, especially into June and July, the higher the risk and probability of Wall St. giving up some of its gains, which would correlate into the USD gaining back against its counterparts. The liquidity will dry up considerably after Memorial Day and with a lack of buying conviction I find it hard to imagine how the S&P 500 could get back to 975 or 1,000 over the summer. So in addition to disinflation being one of the biggest risks for the global markets, summer trading conditions are also a very viable risk, especially in July and August.
As far as trading goes, I'm not bull and I'm not a bear, just an opportunist. I'm not married to either side of the market, my bias is not to buy the dollar and I'll continue with that bias until the S&P 500 starts losing the battle to the USD Index, and then I'll switch sides and fight for the dollar and fight against the euro, very simple.
All was quiet on the geo-political front and central bank front and this also led to a rather tame market on Monday but don't forget we have a Bernanke speech at 1930 EST / 2330 GMT in addition to speeches from Fed Lockhart and Rosengren. Besides a few hawkish comments from Trichet earlier on Monday, all was quiet from the ECB but I'm constantly on the lookout from any rhetoric especially with the Eurozone's fundamentals continuing to deteriorate.
As always, be smart with your risk and money management, stay disciplined with your use of margin and leverage, especially as we roll on this week and the level of fundamentals picks up the pace. I expect to see heightened volatility and some larger price swings between Wednesday and Friday this week.
EUR/USD key levels will be posted before Wall St. opens on Tuesday.
Once again there are an abundance of fundamental, economic, and monetary policy factors weighing on the markets this week but I wanted to cover a few things I feel are important for us traders to think about as we get ready for the trade week.
First, based on a lot of the questions and emails I was getting towards the end of last week I want to cover those before we take a look at the week ahead because all of the questions were virtually the same. I'm going to answer the questions by looking at the collateral damage from the S&P 500 and USD Index battle as it will offer great trading lessons for those traders who were caught off guard or may not fully understand how this correlation works and how I use the correlation to pick market direction and actual trades
If you recall last Sunday's update we took a deeper look at the correlation between the S&P 500 and the US dollar Index. The main reason I chose to talk about that last Sunday was because I was seeing both of those markets, which I consider the 'gods of war'of all financial markets, drawing their lines in the sand and ready to do battle. And it turned out to be quite a battle with the S&P 500 and it's allies gaining a clear advantage over the USD Index.
S&P 500 vs. USD Index:
Between Tuesday and Friday of last week I gave a clear market and trading bias in our chat room and here in the blog: do not buy the dollar and do not buy the yen... short the USD and the JPY against the EUR, GBP, and AUD. Traders were asking me from what basis did I arrive at this bias? Every core underlying fundamental was stacked against the dollar last week and there was no fundamental reason to buy the dollar because all of the dollar's correlated markets working against it and fighting alongside the S&P 500, and when the S&P 500 gains the advantage the USD Index goes down in flames.
Take a look at what the S&P 500 and it's allies did to the dollar last week:
S&P 500 bottom to top move: 884 to 929 S&P 500 futures bottom to top move: 876 to 929 Spot crude oil bottom to top move: $52.50 to $58.80 EUR/USD bottom to top move: 1.3280 to 1.3640 Spot gold bottom to top move: $886 to $926
The dollar didn't stand a chance last week. The USD Index's top to bottom move was from 84.50 to 82.55 and that is a nasty move right there. So to answer those questions on why my bias was to not buy the dollar at all last week, the five markets listed above that correlate directly to the dollar's overall strength/weakness told me everything I needed to know to keep buying the euro against the dollar.
It doesn't matter what any chart, any indicator, or any analyst has to say, including myself, as long as Wall St. continues higher and commodities continue higher, the US dollar will continue moving lower and there is no fundamental basis whatsoever to buy dollars. It's very simple.
How this all translates into what causes me take actual trades is just a three step process. It goes like this:
I pick a side to fight with
I track the 30-minute price opens of the EUR/USD, S&P 500 futures, and spot crude
When the 30-minute price opens show a higher-probability price pattern sequence of those markets exhausting and over-extending to the downside, I buy the euro against the dollar
It's a very uncomplicated strategy but it requires a little patience and staying in tune with all the markets and just going with the flow. The other main question I was getting: "How come good US data is bad for the US dollar?"
When it comes to the fundamentals and economics of the US and how they relate to the US dollar, there is a strong inverse correlation between the two. In my view, how this inverse correlation drives the prices of currencies, equities, commodities, and securities is directly connected to two specific factors:
Forward looking interest rates and the potential future of yields
Risk appetite and market sentiment
The US economy and Wall St. are the financial center of the universe. If the US economy and the US fundamentals are improving, this means the rest of the world will grow or has the potential to grow. This potential for growth leads to an appetite more hungry to take on risk. It basically works like this:
Good US data = higher US equities. Higher US equities = lower dollar. Lower dollar = higher commodities and higher-risk currencies.
When market participants have a healthy appetite for risk what they do is borrow the cheap and low-yielding dollar to buy higher-risk markets because higher-risk markets almost always offer higher yields and interest rates. And when it comes to currencies, the EUR, GBP, AUD, CAD, and NZD all currently offer higher yields compared to the USD. In addition, currently, the S&P 500 and crude also offer the promise of higher yielding returns versus the USD.
When the markets are not in total meltdown panic mode, like they were between last July 2008 and early March 2009, their heightened appetite for risk leads them to send their money-flows into higher-yielding markets that offer a greater potential for better future returns compared to what the potential returns for holding the US dollar offer. Bottomline, the dollar is cheap and in abundance and almost every other market has better interest rates and higher yields.
It is the shift in risk appetite and demand for risk that leads things like Treasuries and the dollar lower against higher-yielding markets. Treasuries are considered the least riskiest asset class and when there is a vast demand for Treasuries, the prices go up and yields go down and the dollar gains strength, but as market participants keep seeing the S&P 500 go up and the US dollar Index go down, it signals "safety" to risk on higher-yielding markets.
If you can wrap your mind around these concepts for what drives prices and patterns of market behavior, it should translate into better trading decisions. Hopefully this answers a lot of those questions I was getting last week and if not, we can cover them during Monday's Q and A session.
Big fundamental week:
Inflation, growth, consumer, and retail sales data will dominate the week ahead with inflation and retail sales being the two biggest and most watched by market participants. Here's a list of the reports I'll be most closely watching this week and using as a gauge to determine risk appetite of the markets and overall market direction:
German Final CPI (Tuesday 0200 EST)
German Wholesale Price Index (Tuesday 0200 EST)
US Trade Balance (Tuesday 0830 EST)
Eurozone Industrial Production (Wednesday 0500 EST)
US Retails Sales and Core Retail Sales (Wednesday 0830 EST)
US Import Price Index (Wednesday 0830 EST)
Crude Inventories (Wednesday 1030 EST)
US PPI and Core PPI (Thursday 0830 EST)
Initial Claims (Thursday 0830 EST)
German Preliminary GDP (Friday 0200 EST)
Eurozone CPI and Core CPI (Friday 0500 EST)
Eurozone Flash GDP (Friday 0500 EST)
US CPI and Core CPI (Friday 0830 EST)
Net TIC Flows (Friday 0900 EST)
Michigan Sentiment (Friday 0955 EST)
Geo-politics and the central banks: I cannot stress this enough... keep your eyes and ears out for any and all rhetoric and comments out of the Fed, Treasury, ECB, BOE, BOJ, and SNB, especially out of the ECB and SNB. The central bankers have been increasing their rhetoric which they use to talk their respective currencies up or down. We know for a fact the SNB wants to devalue the Swiss franc, they have made this abundantly clear to the markets. Back in March they sold the franc on the open market to send it lower against the euro and dollar only to ultimately see their open market operations fail, especially against the euro.
Look at what SNB Roth said last Wednesday:
"We want to halt franc appreciation; SNB will continue currency moves as long as needed; FX action is emergency tool against deflation"
I do not disagree with Roth at all, as you know I'm also concerened about deflation and disinflation, I see signs of it in the fundamentals and as bad as inflation is, deflation is a worst-case-scenario situation for ALL markets. But what some central bankers don't realize is everything we were talking about above... they can perform these open market operations in an attempt to devalue their currencies but as along as Wall St. keeps going up, commodities will keep going up, and when the S&P 500 and crude go up, the USD Index goes down, and market participants keep buying currencies like the franc, euro, pound sterling, Aussie, etc.
The central bankers cannot fight against the collective buying power and money-flows of market participants who are hungry for risk and higher-yields. It's just like what happened to all the traders who tried to short the euro against the dollar last week... it just wouldn't work and won't work as long as Wall St. keeps going higher. So, central banks like the SNB can do all they want in an attempt to bring the franc lower against the euro and dollar, but as long as Wall St. keeps driving the prices of all markets higher, they are fighting a battle they will never win, end of story.
Again, just watch out because the SNB and any other central bank can use the element of surprise to hit the markets when they least expect it and the temporary effect of an open market currency operation can be brutal for those who are caught on the wrong side.
Absolutely not. The move the EUR/USD made last week and especially last Friday has zero to do with the euro being strong. At the risk of being a broken record, I want to re-cap why it gained so much on the dollar which will be the same reasons it could keep gaining on the dollar:
Surprise upside prints on Pending Home Sales, ISM Services, Crude Inventories, Initial Claims, and Non Farm Payrolls
ECB telling markets they will not lower rates in June, they will not monetize sovereign debt, they are not concerned with deflation and the will support credit and lending to the public sector
Treasuries continued moving strongly bearish
Bernanke said the Fed Funds rate would stay extremely low
USD 3-month LIBOR interest rates moved below 1.00% for the first time in history
All banks 'passed' the stress test
The S&P 500 gained almost 6%
The Dow gained 4.4%
Crude oil gained 10%
Those are just a few of the major reasons the euro was able crush the dollar, none of which have anything to do with the euro truly being strong but everything that has to do with how the core underlying fundamentals of the markets affect the price and value of the EUR/USD.
Should those same fundamental and interest rate-connected variables continue to move in tandem and work as they did last week we should expect the euro to keep gaining on the dollar, it cannot work any other way right now. It should be noted that the euro will be approaching some stronger resistance along with the S&P 500 and S&P 500 futures...
For the euro, in recent months there have been two major rejections around the 1.3720 to 1.3750 levels. And for the S&P 500 and S&P 500 futures, there will be stronger resistance between the 935 and 950 levels. Spot crude struggled to slice through the $58 level but as long as equities continue higher, crude may well be on its way to the $61-$62 level.
One of the keys to it all -- the USD Index continuing to move lower. After free falling on Friday we may see a little upside retracement on the USD Index but should this occur, I will be using this as a buying opportunity, not to buy the dollar but buying the majors against the dollar... should the USD Index retrace some of its losses, we may see the euro come back under the 1.3600 level, into the 1.3550's or high 1.3400's. That being said, recent price action trends and market behavior have shown Friday's moves to continue through the Tokyo open on Sunday's so at this point I will absolutely not take a EUR/USD short.
In my view Wall St. will remain the center of the universe this week with the S&P 500 and USD Index continuing their battle. So if I see the S&P 500 is falling against the USD Index, I have no problem switching up my trading bias. At some point the S&P 500 will over-extend to the upside while the USD Index exhausts to the downside and when I see this play out. I'll adjust accordingly, I'm not married to one side of the market or the other but will continue to just go with the flow and stick to what's been working.
How I pick and choose my trades will be based on the 30-minute price opens, patterns that develop over each 30-minute time frame, and what kind of probabilities are showing when a pattern sequence develops in relation to the correlated markets. As always I encourage all traders to be smart with your risk and money management, stick with those 0.5% used margin entries and keeping your usable margin above 96% at all times.
Tomorrow at 1000 EST / 1400 GMT I'll do a live audio Q and A session in the chat and Monday's EUR/USD key levels will be posted before Wall St. opens. There's not much on the fundamental calendar between now and Monday evening when Bernanke gives a speech in Atlanta at 1930 EST, so be on the lookout for that.
For all the hype and speculation about what the ECB could do in regards to their 'non-standard measures', Trichet and the ECB revealed a program that is not even remotely close to what the Fed and BOE are doing. Initially during the first few moments of Trichet's press conference he made the announcement the ECB would buy euro denominated covered bonds but gave no detail other than calling the program, Enhanced Credit Support Operation.
The initial announcement and complete lack of clarity hammered the euro because it did sound like a quantitative easing-type program. Within 8-seconds of Trichet making this announcement to buy covered bonds the euro went from the 1.3340 level to the 1.3250 level, but then the euro rocketed back up after he said the details of this program would not be released until June. After giving market participants a reprieve, the euro quickly recovered above the 1.3400 level as this program was further explained and market participants realized it is not a program to monetize government debt, but to support and stabilize the European banking system.
This new covered bond buying operation was priced at around $60 billion euros and the technicalities will be revealed at the next meeting in June. Trichet said, "$60 billion euro is an appropriate level to help meet objective".
The key thing is, the buying of covered bonds is not a quantitative easing type program, it is not monetizing government debt, it is to stabilize the banking system, loosen credit and lending, and to stimulate the economy with the main objective to get banks to lend more to the public sector. Trichet went on to say no other decisions at all were made to buy bonds and that the decision to embark on this new program was made unanimously by the governing council. Trichet made it clear they were not embarking on a quantitative easing program.
The euro was further supported by Trichet's comments on interest rates. On the future of interest rates Trichet said:
"Current rates are not necessarily the lowest they can go, but sees the current level of interest rates as appropriate"
What Trichet told the markets on interest rates is that there will be no rate cut in June. That is very hawkish and helps maintain the euro's higher and generous yield against the dollar. And then the markets got hawkish rhetoric on the Eurozone's fundamentals. On economic conditions Trichet said:
"Latest data suggests tentative signs of stabilization; we see there is stabilization; Q2 will be much less negative than Q2"
On inflation Trichet said: "Inflation pressure has been rising"
That comment right there was said to put any fears of deflation or disinflation to rest. So between Trichet clearly stating the ECB would not monetize government debt, putting a floor in interest rates, the S&P 500 futures and S&P 500 making strong initial gains, the USD Index getting hammered, spot crude going to $58+, and the 10-year yield surging to 3.27% from a strong Treasury sell-off, the euro had no problem recovering to the 1.3455+ by 0930 EST... every single one of the euro's market correlated variables was working for it, nothing was working against it as Wall St. opened this morning. It wasn't until Bernanke's comments about broader government oversight around 0956 EST that the S&P 500 futures sold-off, pushing the USD Index off of its lows which slowed the pace of the euro's rise and took it back under the 1.3400 level.
Overall, Trichet was the most hawkish and upbeat he's been since last September and market participants were totally buying in to it. Not only was Trichet's strong hawkish rhetoric and tones positive for the euro, the fact the ECB didn't go down the route of the Fed and BOE in terms of monetizing government debt was highly euro supportive. After Trichet clarified exactly what the covered bond buying program was, there was not a single comment or piece of rhetoric that signaled any reason to sell the euro against the dollar. It was Bernanke's odd comments that hurt the euro via the euro's strong correlation to equities in addition to a wrecked Treasury auction.
Bernanke rattles Wall St. and causes sell-off:
In his usual mind-numbing manor, Bernanke delivered a message to Wall St. that they did not want to hear. Bernanke spoke to the Chicago Fed this morning as Wall St. was getting up and rolling and his comments on increasing regulation on banks, reversing repurchase programs, monitoring liquidity risks, and formulating an exit plan to end credit support to the markets stopped Wall St.'s strong open dead in its tracks and caused a nice sell-off. His alarming rhetoric brought risk aversion back into the markets, sending money flows back into the USD, JPY, and Treasuries and right back out of the EUR, GBP, AUD, and CAD. That's just the way it works... Bernanke really hammered the S&P 500 futures, sending them down over 20-points within the first 2-hours Wall St. was open.
But, in my opinion there's a little more to the story today with what happened on Wall St. and the equities sell-off... Botched Treasury auction brings risk aversion and USD strength:
I'm not sure what kind of headlines this is getting, but this afternoon there was a 30-year bond auction that went awry, it was ugly. Within minutes of the auction results being released the S&P 500 futures, S&P 500, and Dow all came under renewed pressure as market participants quickly digested the results and flat out stopped buying equities.
Now typically the lack of demand for Treasuries is a good thing for Wall St. because under normal circumstances it shows that market participants are willing to send their risk and money-flows into stocks and not bonds, but that was absolutely not the case today. On the contrary, this is how market participants show a vote of 'no confidence' in the longer-term outlook and potential performance of the US economy. How market participants send their money flows into Treasuries is a beautiful gauge of how participants view the viability, growth, profitability, risk and safety of the US economy and US government.
Market-movers who participated in today's Treasury bond auction, which is the longest dated maturity offered by the Treasury, forced the government to pay them higher yields in order to park their money for 30-years. Participants were basically telling the Treasury that if they want their money, they've got to up the yields, payout more money, and then they'll buy the government's debt.
Although what happened at today's auction is a bit of an anomaly, this shouldn't come as too much of a surprise if you recall what I wrote in the 26-April update:
In my view, the days of the great Treasury bull run should be officially over. Treasury prices should be starting their march back down while yields should be starting their march back up. Treasury supply should far exceed demand and all of those factors are nothing but bearish for Treasuries.
The results of today's 30-year bond auction were nothing but bearish. In fact, all Treasuries are going extremely bearish just as I expected they would. After today's abysmal auction the benchmark 10-year yield skyrocketed to almost 3.35% after trading around the 3.00% level last week. This is some nasty stuff for the government to have to deal with because with all the untold billions of dollars they need to raise to fund their stimulus programs, now the markets are forcing them to pay more to borrow and that puts US debt at even greater risk. Anyway you slice, it's bad, bad, bad...
Using these fundamentals for trading--
This is one of those fundamental events that has a direct impact on the Forex market and how participants in our market handle their FX positions. For me personally, the first thing I think of is, "how will this fundamental event impact market sentiment, risk, and how participants will react, which then impacts price action and price behavior".
So in this case, after digesting the dismal auction data and figuring the impact would be negative on equities, it caused me to take profit on a GBP/JPY long position. Reason being, my position was in profit, and of course profit is always nice, but knowing that when the S&P 500 comes down, the yen goes up, so I also acted to prevent my position from going into drawdown.
And it's really that simple. Explained another way... lack of Treasury buyers, which force yields higher, translates to negative sentiment, which leads to risk aversion, which then takes the S&P 500 lower, which then pushes crude oil lower, the USD Index higher, and then the dollar and yen gain on the FX market. That's the exact scenario and process that goes on in my mind and then correlates to how I handle any open positions that would be net USD or JPY short in addition to how I take new positions to play this fundamental event and the fundamental factors. In this specific case, as I mentioned, I closed a GBP/JPY long, which is the equivalent of being of being JPY short, thus preventing my position from going against me or decreasing my profit potential.
Non-Farm payrolls to show 16th consecutive month of job losses:
After a long week of mega fundamentals and heaps of central bank rhetoric, we'll go out with a bang as we get the latest NFP and Unemployment Rate data. Now there is some important Eurozone data before NFP, but the only I'm focused on and the rest of the market is focused on is the jobs data. That's all that's going to matter for tomorrow.
Here's what the bank economists and bank analysts are forecasting for NFP and the Unemployment Rate:
NFP consensus range: -580K to -810K Unemployment consensus range: 8.5% to 9.5%
As always, the geniuses at the banks have a nice and tight range there... anyway, my personal forecast is as follows:
NFP: -562K Unemployment rate: 8.9%
I'm not at all a news trader but NFP is the one news event I seek to trade each month. I don't believe NFP itself, no matter how bad the print is, would be enough to knock Wall St. back too far, but I do believe that should this evening's stress test information further spook the markets on top of what Bernanke did to them earlier in addition to the botched Treasury auction, that a poor NFP print will lead to profit-taking on Wall St. And it's the profit-taking combined with the lack of conviction volume buying, and then the stoploss triggering which could bring Wall St. lower tomorrow.
Between what Bernanke had to say and how the Treasury debacle caused risk aversion, Wall St. will be going into tomorrow's NFP event in a rather grumpy mood after being euphoric for most of the week. The S&P 500 was getting over-extended anyway, so there's certainly plenty of reason to see the profit-takers come out and the big, bad bulls sit on the sidelines. Now should we get a nice upside surprise on NFP, which is certainly possible based on recent US data trends, it may bring in some renewed confidence.
For us in the currency market this means the potential for volatile and chaotic price swings and sharp moves. As much as I love trading NFP, if I think market conditions may cause me to give back any of the profits I've made this week, I'm not trading it, plain and simple. Friday's are the day the largest majority of traders lose and give profits back. So for me, sometimes the best way to win is not by trading at all...
If you do trade FX during the NFP news events, pay close attention to all the correlated markets... if money-flows pour back into the S&P 500 and S&P 500 futures, we'll see spot crude gain, the USD Index come lower, and non-risk aversion money-flows head into the EUR, GBP, AUD, and CAD, and back out of the USD and JPY.
At this point my own personal risk and money management plan still calls to not buy the USD or JPY, and to short them against the majors and crosses when my 30-minute data, price patterns, and the correlated markets show. Even with the volatility today, not buying the dollar and yen and shorting them against the majors and yen crosses was a profitible plan, so while it's working and paying out, I'm sticking to it.
The USD and JPY remain in very terrible fundamental condition currently and as long as equities and commodities continue moving north with the help of heightened risk demand for higher-yielding markets, the USD Index will keep moving inversely against the S&P 500, just like we talked about in the Sunday update.
NFP risk management--
Don't forget that between 1700 EST and 2030 EST there will be a heightened potential for stop runs and stop loss triggering in the market, so be on the lookout for that. Also, as Tokyo is closing and Europe enters the market there will be book squaring and positioning ahead of the NFP event, and then again when Chicago futures money hits the market before NY opens. Be smart with your risks and be aware of what time of day it is so you don't get caught off-guard and take an unneeded loss.
That's all for now. EUR/USD key levels will be posted in the morning before NFP. The best risk management advice I can give all traders, especially those who are under capitalized is: DO NOT TRADE NFP...
Just after 0928 EST this morning Standard and Poors cut the ratings on five German banks to negative and within minutes the EUR/USD came lower from the 1.3368 level down to the 1.3271 key level by the 1030 EST time frame. At the same time of the announcement the S&P 500 futures failed to move above the 912 level, dropping several points and that certainly set-up a perfect storm for the euro to tank. Banking downgrades are never a good thing and with Germany being Europe's largest economy, news like this is just plain bad for the euro.
The reason a banking downgrade would pressure a currency and cause it to sell is because of the risk factor. Money managers make their decisions based on these type of risk factors and when a bank is downgraded, especially to negative, it requires a shift in money-flows and the overall risk plan for how money and assets are managed.
A few traders asked me if I took a euro short after this news came out. No, I did not short the euro, but what the news did was get me out of a profitable euro long knowing the EUR/USD had to drop because the fundamentals of a German bank downgrade would make it impossible for the euro to move up any higher and would pressure it lower, especially with the S&P 500 futures and spot crude moving lower respectively at the same time the bank downgrade news hit the markets.
And that's pretty much how market participants handle a situation like this... euro longs produced good profits earlier in the day, then we get a banking downgrade, so market participants are given a great reason to start booking their profits and the euro buying ceases causing price action to move lower, then stops begin getting triggered on those traders who either missed the news or had no understanding of how that would impact the FX market, and you know the rest of the story...
As soon as the S&P 500 and futures recovered after 1400 EST, the euro was back up to the 1.3350+ level in NY afternoon trading.
Stress test results leaked:
All 19 banks undergoing the so-called stress test "passed" but many were deemed under capitalized and will now be required to raise money. I'm not sure how an insolvent bank passes a stress test, but oh well... Here are the results:
Wells Fargo needs to raise $15 billion
Citi needs to raise between $5 and $10 billion
GMAC needs to raise $11.5 billion
Key Corp needs to raise $3.3 billion
SunTrust needs to raise $3.3 billion
What about Bank of America? There's a whole of speculation and rumor for BOA, some are saying they need $30 billion, some are saying they need $35 billion, others are saying they need $70 billion, and the last I heard, they don't need to raise any capital at all... Metlife and Regions Financial also failed the capital requirements test and they too need to raise capital. Goldman Sachs, JP Morgan, Bank of NY, AMEX, and Morgan Stanley all passed the capital requirements test. Keep in mind, this is just the information the Fed and Treasury have been leaking to the markets and they may not be the exact official numbers, we're just getting the numbers the Fed wants us to know. The official results are scheduled to be released tomorrow.
What I'd like to know is not how much capital these banks needs to raise but why they need to raise billions upon billions. It's like if you wake up with your rash all over your body, you don't go to the doctor just to have him say, "you've got a rash", you go to the doctor for him to tell you what the rash is, what the cause is, and how to fix it. We all know a lot of those banks are insolvent but what we're not being told is why they are insolvent, so to me, this test is just another joke and pointless exercise in futility.
ECB rate event outlook:
Tomorrow is the moment the market's have been waiting for... will the ECB follow the Fed and BOE or won't they... first of all, lets look at a few of the facts:
The Eurozone fundamentals are abysmal
Germany remains in full recession
European banks remain under pressure and continue being downgraded
European growth is expected to contract by 4.00%
Debt-to-GDP levels are above EU standards
Evidence of consumer and producer disinflation
Eurozone unemployment expected to rise to 11.5%
Those are just a few of the issues, with the worst being continually contracting growth, rising unemployment, and the worst of all, potential deflation. Europe is under performing against the rest of the world and the European banking system continues to be fractured. Some of the worst banks on the planet are European banks... they remain highly leveraged, insolvent, and on the brink. I'm talking about crap banks like RBS, UBS, Fortis, ABN etc.
Now if it wasn't for the euro's tight correlation to the S&P 500 and the European bourses tight correlation to Wall St. equity markets, there's no telling how nasty things would be looking right now. So, in regards to what the ECB will do with interest rates, I expect the ECB Key Lending Rate to be reduced by 25bps to 1.00% and the deposit rate to remain at 0.25%. Should the ECB cut rates by more than 25bps, that would be viewed as a shock to the markets and we should expect to see the euro sell-off, likewise, if the ECB holds rates at 1.25%, this too would be a shock and the euro should gain good ground against the dollar.
The real question for tomorrow is, what will the so-called 'non-standard measures' be? And will there even be an announcement of non-standard measures? As we've talked about many times the past two weeks, various members of the ECB governing council have been talking the euro up and talking it down in addition to giving strong rhetoric for or against the use of non-standard measures. There's a clear divide on the governing council and some members have come out strongly against buying debt, quantitative easing, and adding more fiscal stimulus.
In it's current state, the Maastricht Treaty forbids the ECB from buying sovereign debt. Basically, law forbids the ECB from doing what the Fed is doing with Treasuries. But as we all know, central bankers are masters of creativity and political spin. We have no idea if any backroom deals were made to somehow magically make it legal for the ECB to buy European sovereign debt, so I think we go into tomorrow's rate event knowing there's a good potential the ECB announces a plan to buy government debt. The probabilities for this happening are not high, but they exist nonetheless.
In order for it to even make logical sense for the ECB to buy sovereign debt they would have to reduce their key lending rate to at least 0.75% but more likely to 0.50%. No matter how you slice it, it makes zero sense from an economic and fundamental standpoint to go down the route of quantitative easing when the bank refinancing rate is at 1.00% or higher. No central banker with half a brain cell would go down the quantitative easing route and forced currency devaluation when interest rates are still higher, they would first take rates low and at least to 0.75% before starting that program.
But, there's no way me or anybody else can predict what Trichet will reveal during his 0830 EST press conference in regards to these non-standard measures, I don't even want to speculate on it anymore. I will not attempt to pre-position myself I'd rather allow Trichet to reveal what he wants and say what he has to say, and then go from there. That being said, if he does reveal a quantitative easing plan, I'll change my bias not to buy the USD right now and I'll sell the euro against the dollar, no questions asked.
Potential euro risk--
Beside the debt-buying risk, the euro is also at risk should Trichet give strong rhetoric about deflation and or disinflation fears in Europe. I cannot stress enough how terrible deflationary pressures are on the euro, it's really a terrible thing. Some of the Eurozone's data shows true disinflation happening in Europe. If Trichet decides to put the spotlight on this issue and warns that deflation could be a real credible problem for Europe, the euro should get hammered. Deflation is a very bad thing for a currency...
That's all I've got to say on the interest rate event. All the market movers will be watching, listening, and dissecting Trichet's every word so do yourself a favor and tune-in. You can watch it here at 0830 EST / 1230 GMT.
New anti-hedging rules from NFA:
Several traders have asked me to comment on the new hedging rules from the NFA. After 15-May, US-based retail FX brokers who are members of the NFA will prohibit the use of hedging (holding a long and short position on the same currency pair). In my opinion I don't see an issue here, reason being, the vast majority of retail traders are under capitalized and don't even belong in the spot FX market to begin with, and when they hedge they get themselves in even more trouble and only hasten a margin call.
It's said over 90% of all retail FX traders lose money and I believe this is due to the problems of under capitalization, over-leveraging, and terrible risk management. I do not advocate under capitalized retail traders making an attempt to hedge their positions. If they can't properly manage 1 position, having to manage 2 opposing positions isn't going to make their life any easier or their trading any better. Hedging should be the last thing on the mind of a retail FX trader, learning proper risk management, how to safely use leverage, and how to better time their trades should be the top priority, especially if the trader is under capitalized and doesn't have the buying power to play in this market in the first place.
Retails traders who are disciplined enough to manage hedged positions can get around this new regulation by taking their money to either a non-NFA member broker or to a non-US based broker. Being a member of the NFA doesn't necessarily make a broker "safe" or scrupulous. The NFA is not a government agency, it's an independent self-regulatory agency, and brokers pay a fee to be a member, they don't gain membership based on their own merits or high standards. In other words, just because a broker is a member of the NFA doesn't mean they don't and won't pull typical broker scams.
For those traders who are upset about this, I suggest filing a complaint against the NFA itself. Hedging is a common practice in trading, it's standard fare, so if you don't like the rule, I'd say the best thing to do is file a complaint against the rule maker. You can file a complaint against the NFA right on the NFA's website... you can click here to access the complaint form. The NFA's own ID number is: 9999998, and in the description box you an state your case against them.
The ECB rate event will be what I'm most focused on between now and the next 16-hours. Once we find out what the non-standard measures are, what the ECB's latest monetary policy is, and what Trichet's view on economic conditions and deflation are, all markets will finally have much more clarity and will be able to take things from there. Again, it's pretty simple, if the ECB decides to monetize debt and or sounds the alarm on deflation, I would not be long the euro.
The other big event on Thursday of course is the BOE interest rate event. I'd be surprised to see BOE take their interest rate below 0.50%. They could do it, dropping their rate another 25bps but now that they've already started their own brand of quantitative easing there's really no need to take the interest rate any lower.
For US markets, we get Intial Claims and then a Bernanke speech at 0930 EST. Later in the afternoon the 'official' results of the stress test are due to be released, but at this point I don't see that factor doing much to hurt Wall St. The Fed did a great job casually leaking information in order to allow Wall St. to digest it all over time instead of hitting them in one shot.
As mentioned last night, I remain highly bearish on the USD and JPY. Buying the dips on the EUR/USD, GBP/JPY, and EUR/JPY has been a great trade for some easy profits but obviously this could all change tomorrow, purely based on the ECB's monetary policy. If the ECB wants the euro lower, it won't be a mystery based on what Trichet has to say at the press conference. The ECB has been great at talking the euro up and down the past few weeks.
In reality, the euro is just as much trash as the dollar, there is no fundamental basis for a stronger euro, but again, due to the stronger EUR/Equities correlation, the euro will almost always gain on the dollar overall when the S&P 500 and crude gain, which sends the USD Index lower. But the ECB's monetary policy could certainly bring a temporary reprieve to some of the euro strength we've seen since failing to break below that 1.2901 mega key level a few weeks ago.
Once we get the big interest rate events off the plate, the market's focus will then shift on Friday's NFP, and that means the usual amount of book squaring and pre-positioning that goes on with market participants. This morning ADP's NFP printed at -491K vs. an expected print of -644K. That upside surprise instantly caused the analysts and market economists to totally rethink their NFP forecasts and almost all of them dropped their forecasted range, hinting at a better NFP print for Friday.
I'm really not convinced NFP even matters much for Friday. A nasty print and surge in the unemployment rate is probably not going to knock Wall St. back too far, if at all. The bulls on Wall St. remain firmly in control, just like the bears were earlier this year, and the longer this rally drags on, the more the shorts get squeezed out, and the more the stragglers begin chasing the market up. And what that all means for us FX traders is, as long as the rally on Wall St. holds and crude keeps moving to the upside, the dollar and yen will need to go even lower, it just cannot work any other way. Wall St. really is a great trade indicator.
As always, strict risk and money management will be imperative on Thursday and Friday. I will have EUR/USD key levels posted before the 0830 EST Trichet press conference and I'll be in the chat during the event.