Part 1 of Weekly Review/Preview: Prior Week Market Movers & Their Lessons For the Coming Week
1. Bond Markets Calm After Greek Default
The biggest market moving event this past week was the absence of spiking GIIPS bond rates in reaction to the prior week’s Greek default. That calm allowed risk assets to break higher after being tightly capped for the past 4 weeks, as shown in the S&P 500’s weekly chart below (ellipsis B).
S&P 500 WEEKLY CHART MARCH 2011 – MARCH 2012
Courtesy of metaquotes software corp. and the sensibleguidetoforex.com 02 MAR 18 0050
Given that the ECB’s LTRO operations to keep EU banks liquid have done nothing to address the more fundamental solvency problems of the GIIPS and their banks, we believe that this first default of the EU crisis will not be the last, neither for Greece nor the rest of the GIIPS. Bond markets will eventually remember this and send GIIPS sovereign and bank borrowing costs higher to compensate for this risk. That spike in bond yields will signal the next phase of the EU crisis. It’s unclear when that will happen, but given the recent struggles of just Portugal and Spain, along with the EU’s inability to fund a firewall large enough to discourage speculative attacks on GIIPS bonds, it’s only a question of if, not when.
Back in July 2011, the mere threat of haircuts sparked a new phase of the EU crisis. So why then, did credit markets decide to forget that the EU had just allowed the hand that fed it to be bitten? Certainly part of the reason is that the news was already priced in, but that was also the case last July, though perhaps to a lesser extent. We suspect part of the explanation involves:
- sheer fatigue about the Greek issue
- a desire to test recent resistance like the 1360 level on the S&P 500
However these reasons are pure speculation on my part?
Ideas, oh esteemed readers? I’m open to your input and I’m sure the rest of the readers would be interested.
2. That Calm Allows Markets To Move With Upbeat Data
With EU worries on hold, once markets absorbed China’s poor trade deficit report Monday, risk assets spent the rest of the week moving higher, with the bellwether S&P index finally breaking past resistance of the past month at 1360 to reach 4 year highs. The driver behind the move was a batch of overall positive data that is likely to have only short term influence, but was good enough to make the rally happen. The main risk appetite drivers were:
- Tuesday: better than expected German ZEW survey, US core retail sales (which confirmed that the up-trend in US jobs was real and helping US spending and thus US GDP), and positive US bank stress tests results.
- Wednesday: The positive momentum and Italian bond auction allowed markets to suffer minimal losses despite downbeat remarks from the Chinese Premier Wen Jiabao on home prices and news of the 4 US banks that failed the stress tests.
- Thursday & Friday: Firm readings on US jobs and manufacturing Thursday allowed for modest gains and most major indices closing up 2% for the week.
Lessons & Ramifications For Coming Week
Here are the big take-away lessons from last week.
1. EU Calm, Light Data Could Bring Modest Profit Taking
As long calm prevails on the EU, barring any nasty surprises like a war with Iran, markets will be moving on week to week data. This week’s calendar is a typical light mid-month affair, unlikely to spark major moves either way. However with both major stock indices and other risk assets at multi-year highs and little fundamental fuel for further moves higher, we could see markets succumb to some profit taking.
2. The USD Rally: Drivers And Outlook
The USD index has been trending higher for the past 3 weeks, as part of a larger uptrend that began in August 2011. Its continued rally in recent weeks, along with other risk assets, has been a key story recently, because the USD is a safe haven asset that generally moves in the opposite direction of risk assets like stocks and oil.
Why The USD Rally?
The primary forces behind this rally have been:
- Fear from both forecasts of slowing global growth for 2012 and particularly from risk of a disorderly Greek default that could spark a wave of sovereign and bank insolvencies, and crash global financial markets. We see clear evidence of that fear from the weekly S&P 500 chart, which shows the rally that began in September 2011 capped around 1360 for the 4 weeks prior to last week, as shown in the chart above(labeled B).
- Because the fear centered on the EU, the resulting EUR weakness meant USD strength. That’s because the EURUSD comprises about a third of all forex trade, so for every 3 EUR bought a USD is sold & vice versa, so the two currencies push each other in opposite directions like children on seesaw.
- In the past months, both the Swiss (since September 2011) and Japanese (since February 2011) central banks have been intervening in forex markets to weaken their currencies in order to support their exporters. That caused the USD to become, by default, the preferred safe haven currency.
- Good US jobs and spending data raised expectations for more USD supportive policy from the Fed. Specifically, the data both reduced the chances of further dollar-devaluing stimulus programs, and raised interest rate increase hopes and thus also USD demand. Meanwhile, other central banks, especially the ECB, were moving in a more dovish direction that undermined their currencies.
Why USD Rally Stalled Thursday And Friday
However the USD rally stalled late last week. Here’s why (paraphrased from Kathy Lien of fx360.com):
1) The USD Technically Overbought: The US dollar had strong rally over the past month, particularly against the JPY, became overbought in the near term, and thus ripe for a normal correction. However, we believe the longer term up trend for the USD index remains intact.
2) Treasury Yields Fail To Advance: Secondly, the dollar had been rising along with 10 year U.S. Treasury yields (reflecting rate increase hopes), so lack of further gains kept the USD back.
3) Risk Assets Continue Rallying But Without New USD Positive Data: With the S&P 500 at its highest level in 4 years demand for safe-haven currencies like the USD has weakened. The USD has been able to rise with risk assets as the data behind the rally was also good for the dollar, like upbeat jobs and consumer spending. Without more such data, risk asset rallies will continue without the USD.
4) The USD was hurt hit by S&P’s confirmation that the U.S. rating outlook remains negative, and that it’s unlikely that any economic improvement would return the AAA rating anytime soon.
Looking at a weekly chart of the USD index, it’s clear that it’s up trend remains intact barring a decisive break below 78, which would mean a break below the dual support of both:
- The uptrend line ( solid red)
- The 38.2 Fibonacci Retracement Level
USD INDEX WEEKLY CHART 22 MAY 2011 - 11 MARCH 2012
Courtesy of metaquotes software corp. and thesensibleguidetoforex.com
03 MAR 18 0110
Going forward, we believe the USD is still more likely to end 2012 higher than its current level, because the above mentioned forces behind the up-trend remain intact. Specifically:
- The EU crisis is likely to continue to undermine the EUR and risk appetite
- The Swiss and Japanese central banks remain committed to weakening their currencies
- Expectations for the US economy (slowly improving) contrast favorably with those of the EU and China (both slowing down).
Protecting Your Assets From Central Bank Predators
In the course of my work I read a lot of great articles and books, but I rarely find one that makes me want to jump up shout to everyone that they’ve got to read this.
I found one this week, though. You’ve got to see this: Central Bank Regime Change: Who Cares About 2% Inflation Targets Anymore? A Chart. The key point that everyone must be aware of: the central banks behind most major currencies are “busily pressing real rates into negative territory to “erode the debt burden through stealth inflation … in the U.K., the eurozone, and the U.S., central banks are keeping bond yields low enough to stop their governments from going bust – and that’s not going to change for the foreseeable future.” (hat tip to seekingalpha.com’s market currents section for bringing this to my attention)
That means their driving down the value of their currencies and anything denominated in them — like your portfolio.
While most investors understand the need to diversify into different asset classes and sectors, most of us ignore the basic principle of diversification when it comes to currency exposure, and have almost all of our assets denominated in a single currency, be it the USD, EUR, GBP, JPY, whatever.
Failure to diversify into the strongest currencies is just as reckless and foolish as any other failure to diversify.
While this problem is obvious, the possible solutions are not. I’ve spent years seeking them, ever since the Great Financial Crisis broke in 2007 and I suspected the central banks would pursue the silent tax of inflation. Here’s the result of that research: The Sensible Guide To Forex, Safer Smarter Ways to Survive and Prosper from the Start (John Wiley & Sons, 2012). It’s the first book to show how conservative, busy mainstream investors, those with limited time and risk tolerance, can tap forex markets to hedge currency risk and improve returns, regardless of whether they’re active traders or long term investors with no interest in trading at all.
I apologize if this sounds like naked promotion, but the need for this kind of book is very real and utterly unfilled. I couldn’t find any book or resource that pulled together such a wide range of solutions for different kinds of investors with different needs and risk tolerances, all in one neat package.
Like my articles, this too arose out of my own search for clarity & solutions that I wasn’t finding elsewhere.
Just click the above link for a more detailed description of the book, and judge for yourself. As we approach the fall publication date, you’ll be able to look inside the book for further details.
Disclosure/disclaimer: No positions. The above is for informational purposes only. All trade decisions are solely the responsibility of the reader.