Given the likelihood of continued MENA unrest and resulting high oil prices, the seismic shift in forex markets last week, and the coming week’s far lighter economic calendar, much of the coming week’s likely market movers can be seen by examining the prior week. Following are the prime market moving forces of the prior week and the lessons they suggest for the coming week.
While there were a number of noteworthy events and movements last week, only two were clear market movers that actually affected trends. Both are likely to dominate this week’s markets too.
MENA Unrest, Its Affects On Oil Prices Continue Dominating Markets, & Lessons For The Coming Week
For the second straight week, virtually all major financial markets moved mostly based on their perception of how unrest in the MENA (Mideast North Africa) region was impacting oil prices.
A picture is worth a thousand words. Note what the primary picture of optimism, the S&P 500 chart below, click to enlarge, (Monday marked by arrow pointer) suggests about the correlation of last week’s market action to events in the MENA region.
S&P 500 DAILY CHART COURTESY OF ANYOPTION.COM 14MAR06 0225
- On Monday stocks rallied on news that Libyan oil production was rising as rebels allowed oil to flow from regions under their control
- On Tuesday, markets fell as these hopes proved false, and on news of new unrest in Bahrain and (gulp!) Saudi Arabia.
- News of a possible Venezuelan sponsored peace deal for Libya, however outlandish, supported a market rally in the following days, and much of Friday’s pullback in stocks was from Libyan rebels’ rejection of that plan, and a Libyan counterattack on rebel strongholds and oil production areas that further threatened what remains of Libyan oil output.
A look at the weekly S&P 500 chart below, click to enlarge, shows that the 6 month old rally in risk assets has clearly stalled out.
S&P 500 WEEKLY CHART COURTESY OF ANYOPTION.COM 16MAR06 0353
The correlation between the loss of upward movement and the cut in oil production from Libyan unrest is obvious, as is the lesson going forward.
Until oil prices show some signs of pullback, the rally is likely over unless the markets can find new fundamental reasons that suggest growth can continue despite a roughly $15 jump in oil prices over the past 3 weeks.
It is widely believed that GDP of oil importing nations falls 0.2% for every $10 increase in oil.
Last weeks’ events suggest things are getting worse:
- The conflict in Libya worsening as both Gaddafi and the rebels vow to fight on, and
- Unrest spread closer to the gulf states, source of 40% of world oil supplies.
- Rumors of Saudi tanks moving to help quell Shiite unrest in neighboring Bahrain
- Saudi arrest of a leading Shiite cleric here
- Per gulfnews.com, here, a Saudi ban on all protests after minority Shiites staged minor disturbances in the oil producing eastern province proposed March 11 ‘day of rage’, with security forces given the authority to take all steps needed to quell any disturbances, which if nothing else suggests the government is very nervous.
While the above chart still shows strong upward momentum, that uptrend has yet to show it can continue while MENA unrest is causing oil prices to spike and the situations threatens to get worse.
Trading Ramifications For Next Week March 7-11
That means prudent short term trend traders will hold off establishing new intraday or multi day positions until we see evidence of a tradable trend, either:
- A move past prior weeks’ highs on the S&P 500 of about 1350
- A break below recent near term support around 1300
Otherwise, we risk trading in a choppy range bound market that is harder to trade profitably.
A Stock Index Binary Option Trading Example: The S&P 500
One can play these short term moves via direct spot market trading of this index via a variety of vehicles or related ETFs like:
- US: SPY, DIA, QQQQ, etc.
- Europe: ADRU, FEZ, FEU, EZU, VGK, etc. (see here for more)
- Asia: EPP, ADRA, FNI,PAF, IFAS, etc. (see here for more)
However for daily or hourly moves we prefer the simpler, safer risk/reward picture of binary options for this kind of short term speculation.
Those trading the S&P 500 via binary options on hourly or daily expiration times, check its charts on smaller time frames(1-10 minutes for those trading hourly or daily expirations, 30-120 minutes for those trading multi-day or intra week moves) and wait for either:
New evidence of continued up trend favoring new long positions. For example:
- The index holds above its current level around 1320 for a number candlesticks, before going long
- Ideally we’d like to see it test back down to significant near term resistance around 1300 and then bounce higher
If so, then go long the index by buying call options with hourly or daily expirations. The same strategy can be applied to other stock indexes or risk assets for which binary options are available.
While most binary option brokers only offer hourly or weekly expirations, there are some that also offer weekly or monthly expirations for those seeking to play longer term trends.
Evidence of a reversal and new down trend favoring new short positions. For example:
- The index heads lower and breaks below 1300 for a number of candlesticks
- Ideally we’d want to see it test back up to 1300 and then bounce lower
Under these conditions binary option traders would play the down trend by buying put options with hourly or daily expirations.
The same strategy can be applied to other stock indexes or risk assets for which binary options are available.
ECB Confirms New Hawkish Shift On Interest Rates
The only other market moving event last week was the ECB’s announced policy shift to rate hikes sooner than expected. The affects of this one were largely confined to currency markets (and thus of course bonds too). Here are the key points.
Despite the deteriorating situation among the PIIGs block, the ECB sent a clear signal at its Thursday press conference that it will be raising rates sooner than previously indicated.
Specifically, Trichet invoked the same code words he used during the Bank’s previous tightening cycle when he said that “strong vigilance” is warranted with a view to continuing upside risks to price stability. In the past this signaled that a rate hike was imminent.
Although the ECB doesn’t pre-commit to a rate decision, he added that he expects rates to rise by 25 basis points and that a rate hike next month would not signal the start of a tightening cycle.
Currency traders scrambled to re-adjust interest rates armed with this new information. Three-month euro Eonia swap rates soared 10 basis points to their highest level in 2 years, while Euribor – the inter-bank lending rate – also moved higher. The EURUSD jumped, and is now expected to continue to test at least the 1.4000 level next week.
Markets now expect Trichet to announce a rate hike as early as April’s meeting, and are pricing in a roughly 125 basis point increase in the coming year.
Note however what the hourly EURUSD chart below shows (click to enlarge).
EURUSD HOURLY CHART COURTESY OF ANYOPTION.COM 15MAR06 0249
After an initial, 100 pip (0.72%) rise to the 1.390 area, the EUR made little upward progress. This suggests that much of the news was already priced in. It also raises questions about how much near term upward energy the EUR has.
LESSONS, TRADING IMPLICATIONS FOR THE COMING WEEK & BEYOND
Despite ongoing potentially fatal problems with the EU debt crisis, the EUR has rallied over the past weeks on a combination of:
- Rising risk appetite
- Rising interest rate hike expectations
Most of the rate hike expectations have now been priced in, leaving continued EUR up trends depending on rising risk appetite. However, as noted above, risk appetite has yet to show that it can continue higher while MENA unrest is causing oil prices to spike and the situations threatens to get worse.
Thus while we must respect and continue to trade with the EUR’s near term up trend, we must suspect it’s durability and be ready to play the short side on any signs of profit taking. The likely fundamental catalysts to watch are new MENA unrest bringing rising oil prices or bad news in the EU debt crisis. Beware also of simple technical pullbacks after failed attempts to breach key 1.400 resistance.
Beware, however, that while the move to raise rates may help fight inflation, it increases risks of stagnation and possible sovereign debt default for the PIIGS nations, which we regard as a greater near term risk than inflation for the EZ.
- The new Irish government was elected with a mandate to negotiate a better bailout deal, and will push hard to extract some concessions to show its voters or risk a quick exit from power a replacement by more militant parties (i.e. Sein Fein).
- Yet any concessions the EU grants will mean similar treatment for Greece and Portugal (expected to need a bailout within the coming weeks).
- However, any such concessions mean a loss for the ECB and EU banks holding the bonds, new uncertainty about the EU banking system, or a subsidy that must be paid by someone.
- Meanwhile, the prime EU paymasters, German officials, have another local election coming up and have thus shown little inclination to accommodate the PIIGS with yet further gifts while angry German voters are watching and waiting to express their anger at further giveaways of their taxes.
These issues will come to the fore at this coming Friday’s EU economic summit, and may spark new volatility in the EUR pairs, especially with the Euro already overbought in the near term.
How To Profit/Short Term Trade Ramifications
The EURUSD and EURJPY are the cleanest plays on the EUR and risk appetite, with both the USD and JPY likely to move opposite both the EUR and overall optimism. For simplicity we focus on the EURUSD as an example, but the same ideas apply to the EURJPY.
For those playing short term EURUSD intraday or multi-day trends, while momentum is still firmly upwards, we are very close to key 1.4000 resistance for the EURUSD, thus it’s wisest to wait for the next test of near term resistance 1.4000 or support around 1.3835.
A Binary Option Trading Example
While one can play these short term moves via direct spot forex trading of these pairs or related ETFs (long the EUR:FXE, UDN, short the EUR:UUP, FXY), for daily our hourly moves we prefer the simpler, safer risk/reward picture of binary options for this kind of short term speculation).
Consider going long on a breach of 1.4000 resistance IF:
- In your chosen trading time frame (hourly, daily, or longer) oil prices are falling AND major stock indexes are rising. We want to see both of these happening together to feel justified about further longs on these. We also want to see…
- The pair holds above this level, for at least a few candlesticks on a shorter time frame. For example, those trading the EURUSD via binary options on hourly or daily expiration times, check EURUSD charts on smaller time frames(1-10 minutes) and wait for the pair to hold above 1.4000 for a few candlesticks. Ideally we’d like to see it test back down to 1.4000 and then bounce higher before going long on the pair by buying EURUSD call options.
Consider going short the pair on a breach of 1.3835 support IF:
- In your chosen trading time frame (hourly, daily, or longer) oil prices are rising AND major stock indexes are falling. We want to see both of these happening together to feel justified about further longs on these. We also want to see…
- The pair stays below this level, for at least a few candlesticks on a shorter time frames as noted above. Ideally we’d want a retest up to 1.3835 on the EURUSD and a bounce lower before committing to new short term shorts.
Disclosure: Author is short the EUR for personal portfolio with no leverage as a multi-week trade awaiting a EUR breakdown as the reality of restructure dawns.
Disclaimer: The above is for informational purposes only and not to be construed as specific trading advice. Responsibility for trade decisions is solely with the reader.