Coming Week Market Movers: Contagion Warnings, FOMC, Top Trends, Calendar Risks

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Includes: DIA, QQQ, SPY, UDN, UUP
by: Cliff Wachtel

Part 2: Coming Week Market Movers

See Part 1 for our review of last week’s top market movers and their lessons for the coming week

SUMMARY

1. Greek Default, Haircuts Risk Repeat of July 2011 Contagion

2. Will EU, FOMC Meeting, Risk Appetite, EURUSD Weekly Trend Fuel Further USD Gains?

3. Other Top Calendar Events

1. Greek Default, Haircuts Risk Repeat of July 2011 Contagion

Remember how Italian bond rates started spiking only in July 2011 after PSI risks entered market calculations? That was because the operating assumption up to that time was that the EU would not bite the hand that feeds it and so would not let private investors get hurt. Unfortunately, the EU just couldn’t afford it, neither economically nor (especially) politically given voter and opposition party rejection of baring bailout burdens alone while bankers avoid paying for their own bad decisions.

With that assumption debunked, market reaction was swift and severe. Bond yields spiked, not only for the usual suspects, but now also for Italy and France. Equally disconcerting was that EU banks as a group became tainted by association. Getting overnight loans for normal operations became more expensive or impossible to obtain, leaving many on ECB life support. Contagion had arrived, not only at too-big-to bail Italy, but also at the doorstep of the core funding nations. EU bank shares plunged, leading to a ban on their short sales.

We’ll soon find out if we’re about to get a repeat of July 2011. Keep an eye on:

  • EU bank shares – consider shorting them while you still can.
  • GIIPS bonds CDS spreads and bond yields

2. Will EU, Risk Appetite, FOMC Meeting, EURUSD Weekly Trend Fuel Further USD Gains?

As noted in Part 1, events in the EU (along with technical resistance on multiple risk asset charts) bolstered the case for coming pullback in risk assets that would benefit safe haven assets like the USD.

Last week the USD was the top performer. Note that it has, by default, become the preferred safe haven currency.

Why The USD The Top Safe Haven Currency

Essentially, the other two classic safe haven currencies have seen their safe haven status compromised over the past year.

The CHF- Hit By EU Debt Crisis, Intervention Threats

Firstly, about 60% of Swiss exports go the EU, tying Switzerland’s fate to that of the economically weaker EU. That connection alone has been enough to hit the CHF in times of rising concern about the EU. For example, note in the monthly chart below, note how the CHF has dropped vs. the USD in times of rising concern about the EU debt crisis.

ScreenHunter 01 Mar 09 13 37  Coming Week Market Movers: Contagion Warnings, FOMC, Top Trends, Calendar Risks

USDCHF MONTHLY CHART NOVEBER 2009 – PRESENT

(CHART COURTESY OF metaquotes software corp. AND thesensibleguidetoforex.com 01 MAR 091337)

In other words, bad times in the EU are assumed to ultimately hurt the Swiss and the CHF.

Because of the EU Crisis and its downward pressure on the EUR and the competitiveness of Swiss exports, we have a related but distinctly separate problem – and vigorously interventionist SNB that is determined to limit or prevent the CHF’s appreciation despite its safe haven appeal, and keep the EURCHF around 1.2.

So despite Switzerland having a much healthier, lower debt balance sheet than either Japan or the US, any gains in the CHF can be quickly erased by SNB action, and that has driven away safe haven flows from the CHF.

The JPY: Threatened By BoJ Intervention, Possible New Trade Deficit Trend, Debt/GDP Levels

Meanwhile the JPY’s #1 safe haven currency status has been compromised by the dual blows of both active BoJ intervention AND, just recently, the first Japanese trade deficit in many years. Note that Japan’s long record of strong trade surpluses has been the key for keeping its bond rates low despite Japan’s having the highest debt/GDP in the developed world, around 200%.

For perspective, keep in mind that 200% rate is far above that of Greece (~130%) or any of the GIIPS.

Markets have long tolerated this high debt level for the same reason a bank will lend to those with high debt as long as their income is sufficiently high to cover the debt service and other ongoing expenses. However, if the trade deficits become more common, Japan’s current 1% rates on 10 year JGBs could soar and suddenly make the not insignificant impact of Greece’s debt troubles look trivial.

For perspective, consider that even with 1% rates, Japan’s debt service consumes over 25% of its budget. If those rose to just 2%, Japan’s debt service would double and consumer over half its budget. Note that 2% on 10 year bonds is still quite low (the US has been paying 3-4% for years). Japan is also the third largest economy in the world, so everyone is exposed to the via bonds ownership and supply chain ties.

Yes, unlike Greece, Japan can always print money and pay bondholders – as long as bond markets are willing to accept 2% return paid in rapidly devaluing Yen.

In sum, the more fear or risk aversion over the course of 2012, the better for the USD. Bad times for the global economy generally mean good times for the value of the USD. How will you monitor global sentiment? The S&P 500 chart is my favorite quick and dirty version. There are many ways, but a discussion of them is beyond the scope of this article. I cover other ways to monitor risk appetite in my coming book due out this September, The Sensible Guide to Forex: Safer, Smarter Ways to Prosper From the Start.

FOMC Meeting Could Provide Further Fuel For USD Rally If QE 3 Hopes Reduced

An improving U.S. economy has made investors and central bankers more confident about the recovery. Fed Fund futures show a 62 % chance of a rate hike by January 2014, prompting a number of economists to forecast a 2013 rate hike, which is far earlier than the Fed’s current estimate.

The continuation of the USD rally will hinge upon the tone of Tuesday’s FOMC statement. If it continues to acknowledge the improvements in the economy and places greater emphasis on inflationary pressures, the dollar could extend its gains as this would reinforce the market’s belief that QE3 is no longer necessary. However if the central bank sounds cautious and downplays inflation or growth, the greenback could retreat quickly as such remarks would boost QE 3 expectations and reduce rate increase hopes.

The EURUSD Technical Picture Suggests More Downside Ahead

The below weekly EURUSD suggests the following:

ScreenHunter 01 Mar 11 05 12  Coming Week Market Movers: Contagion Warnings, FOMC, Top Trends, Calendar Risks

EURUSD WEEKLY CHART MARCH 2011 – MARCH 2012 COURTESY OF metaquotes software corp AND thesensibleguidetoforex.com 01 mar 110512

  • An overall downtrend in place since April 2011 that has reasserted itself in the past 2 weeks
  • The pair remains stuck in a well established declining channel since September 2011, the upper boundary of which was tested and held for the third straight time in the past year, just 2 weeks ago
  • Its 10 (blue) 20 (yellow) 50 (red) and 200 (pink) week EMAs are all trending lower, with the shortest durations below the longer ones, suggesting a firmly established downtrend

3. Other Top Calendar Events

This week is a typical moderate event risk week that follows the heavier economic calendar of the first full week of the month. Again, EU debt crisis events could dominate. If all is quiet in Europe, then the FOMC statements are the next likely big market mover.

  • TUESDAY: JPY – BOJ rate statement and comments, EUR – ECOFIN meeting, German ZEW economic sentiment, USD – retail sales, FOMC statement
  • WEDNESDAY: GBP – weekly claimant count, USD – Bernanke speaks
  • THURSDAY: USD – PPI, TIC long term purchases, Philly fed mfg index
  • FRIDAY: USD – core CPI, preliminary UOM consumer sentiment

Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.