Cliff Wachtel's  Instablog

 PRIOR WEEK FEBRUARY 4-11: Bullish Stimulus – Fed Upward Momentum Again Overcomes Bearish EU Fears

 

Here’s a summary of what was driving global markets this past week.

Upward Momentum Overcomes Worries About EU, Mideast Turmoil

 

Risk asset markets kept rising this past week as the stimulus fueled uptrend again overcame anxiety over the EU debt Crisis, Egyptian unrest, and Chinese attempts to cool growth.

 

However, for the second time in 2 weeks, mid-week EU worries temporarily pressured risk assets lower and actually did bring a few days of lower or flat closes.

 

Two weeks ago it was Trichet’s dovish remarks that revealed pessimism and reduced interest rate hike hopes for Euro-Bulls.

 

This past week, we had 4 bearish EU events:

 

1. There was a Belgian think tank report out Tuesday saying Greek default was inevitable. That in turn brought a heated insistence Wednesday by ECB Board Member Lorenzo Bini Smaghi that Greece must avoid default regardless of domestic pain in order to avert a banking crisis. Also this past Wednesday:
2. Ireland halted further bailout funds to Irish banks until after the next election due to concern that the new government would stop bailouts unless private bondholders agreed to accept less, suggesting that banks and other credit holders of Irish as well as Greek bonds will be taking losses,
3. Axel Weber, the leading candidate to replace ECB head Trichet dropped out of the race, followed by widespread reports that he did so in response to widespread ECB opposition to his anti-bailout stance. The move suggests an increasingly dovish ECB that would allow the EUR to weaken
4. Then Thursday Portugal had a poor debt auction that forced the ECB to intervene and buy the bonds in order to keep Portuguese debt from going even higher. Yields on benchmark 10 year notes are already well above the 7% ‘red line’ believed to signal Portugal can’t afford to access credit markets and needs a bailout.

 

 

Second Tier Market Movers

 

A China Rate Hike and Dovish RBA comments combine to pressure both Asian stocks and the AUD lower.

US bond rates have been rising relative to those of Japan and the EU. This fact has been driving the USDJPY higher for the second week, and we could see this continue until we hit the 89-91 range. This may be a partial cause of USD gains against other majors like the CHF, EUR, and GBP.

 

 

COMING WEEK FEBRUARY 14-18: Bearish EU Anxiety Vs. Bullish Stimulus Fueled Up Trend In Risk Assets

 

As with this past week, we see the primary market movers line up as follows.

 

Bullish

 

Upward technical momentum and indicators suggest risk appetite can continue to climb the wall of worry built by the EU, Egypt, China, and elsewhere. This momentum is significant. Note the weekly chart below for the S&P 500, our favorite single picture of risk appetite.

 

 

S&P 500 WEEKLY CHART COURTESY OF ANYOPTION.COM   04 FEB 13 1647

 

Very strong momentum indicators include:

 

• The steep slope of the uptrend over the past 10 weeks. Note how the index has stayed firmly within the upper 2 golden Bollinger Bands. That zone is known as the ‘Bollinger Band Buy Zone’ because it suggests strong upward momentum.
• The 20 week simple moving average (SMA) in purple has already crossed above both the 50 (blue) and 200 week (red) SMAs, which tells us that price has been accelerating over the past 20 weeks
• The 50 week SMA is approaching a cross above the 200 week SMA, an even more bullish momentum indicator

 

Bearish

 

 

To halt or reverse this long built up momentum, markets will need to see some kind of strong fundamental justification for taking profits or going short risk assets. There are a number brewing in the background but none has really become an immediate problem, and markets only respond to imminent issues. The most likely source of really bearish news is the EU sovereign debt and banking crisis. For more on this see:

 

Market Drivers for the Coming Week: EU Deja Vu, How to Profit Too

 

Is a PIIGS Debt Restructuring Coming?

 

The EU’s Dilemma, And the Only Real Solution Left

 

7 Stages of the EU Panic Cycle: Understanding and Profiting, Part I

 

7 Stages of the EU Panic Cycle: Understanding and Profiting, Part II

 

 

 

EU SOVEREIGN DEBT/BANKING CRISIS ANXIETY

 

Could this week’s EU Finance Ministers Meeting Calm Markets, Avoid Another EU Crisis?

 

 

Fundamental Analysis

 

 

Bond markets want an expanded EFSF (PIIGS bailout fund) to minimize the risk of a sovereign default over the next two years, because the current plan is too small to fund the most likely coming bailouts, Portugal and Spain. Though Spain vehemently denies needing one thus far, once Portugal takes a bailout the risk of Spain needed one rises significantly for a number of reasons. These reasons include:

 

• A loss of confidence in PIIGS debt in general that will pressure Spanish bond yields and thus borrowing costs higher
• Extensive Spanish exposure to Portugal default risk

 

Obstacles To Resolving The EU Crisis

 

1. However German officials, mindful of German voter opposition to more bailouts,  oppose both expanding the size of the fund and allowing it to purchase peripheral government debt in the secondary market, two key measures that markets were counting on to keep the EU and EUR stable. To win Germany’s needed support and funds, any new plan needs to include strict enforcement mechanisms. However…

 

1. Italy opposes any annual debt reduction targets, undermining both the chances of German cooperation and the EU’s attempt to convince markets that European countries can get their debt under control quickly.

 

Without these critical parts of the coming new EU rescue plan, markets are once again losing faith in the EU’s ability to manage the crisis. While negotiations may still produce a more credible reinforcement of the EFSF, markets seem to be pricing in disappointment and renewed fears of inevitable debt restructuring.

 

Could we be seeing a repeat of last year’s events, in which the EU fails to show decisive action spooks markets, causes PIIGS rates soar, more panic, followed by a banking and market crises like that of the Spring 2010?

 

For full discussion of these questions see: Market Drivers for the Coming Week: EU Deja Vu, How to Profit Too

 

 

Technical Analysis

 

Euro-zone finance ministers are holding a regularly scheduled meeting early next week and we will be alert for shifts in bargaining positions. However traders are well aware of the above bearish fundamentals, as reflected in the below EURUSD chart, which is showing bearish signs.

 

Note the weekly EURUSD chart below.

 

EURUSD WEEKLY CHART  COURTESY OF ANYOPTION.COM  06 FEB 13 1919 L

 

 

The EURUSD has failed repeatedly to get above the 1.3750-1.3800 resistance zone. The pair closed the prior week sitting on key support of the 38.2% Fibonacci retracement and 200 week moving average around 1.3550.  A decisive break below leaves the pair open to test down to the next resistance on its weekly chart to 1.3400 zone, where is has the support of its 50% Fibonacci retracement line and its 50 week moving average.

 

 

 

 

TUESDAY’S THE DAY FOR THE UK: BOE INFLATION REPORT AND INFLATION DATA LIKELY TO MOVE THE GBP AND RELATED CURRENCY PAIRS

 

Tuesday’s inflation report will provide clues about whether the BoE is as hawkish as markets anticipate, and the CPI data that same day will suggest how much inflationary pressure there is to force the BOE’s hand. Thus far it has been unwilling to risk the UK’s recovery by raising rates, and we suspect this policy will continue as long as inflation stays below a 4% annualized rate. Like the EUR saw last week, any disappointment in inflation expectation

 

 

 

Anticipated increase in short term UK interest rates have been the prime driver of GBP strength in the past weeks.

 

As we saw with the EUR last week after Trichet’s dovish remarks, the GBP could drop if:

 

• The BoE indicates that it remains opposed to rate increases in order to avoid further pressuring the UK’s tepid recovery, or

 

• Inflation comes in lower than expected

 

If however,

 

• Inflation is at or above the anticipated 4% (2% above the 2% inflation target), CPI comes in higher than expected, AND/OR

 

• The BoE inflation report leaves room for the chance of a rate increase

 

Then markets may assume the BoE will be forced to raise rates. If so, the GBP could well resume its strength.

 

Note that while it’s clear that prices are rising in the UK, part of that is due to the increase in the sales tax. Meanwhile anticipated slowing growth from austerity cuts have yet to be felt, even after last month’s surprise GDP contraction, making the risks of recession from a premature rate increase as dangerous as the risks of inflation from making one too late. UK policymakers face a choice between the lesser of 2 potent evils.

 

 

 

How To Profit

 

In General Continue To Avoid Shorting Risk Assets

 

From A Technical Perspective Overall Risk Appetite Remains Robust And Looks Durable

 

Regardless of the dour fundamentals from the EU, UK, China and Japan, the robust technical picture of the past months noted above has proven correct thus far and thus we generally avoid establishing short positions on risk assets at this time.

 

In sum, despite looming concerns about slowing growth and inflation in the EU, UK, Japan and China, as well as a tepid improvement in growth in the US, risk stimulus cash is working.

 

Cracks In The Technical Foundations Of This Rally?

 

However, Asian stocks, forex, and bond markets are flashing warnings.

ASIAN STOCK INDEXES

 

Note however that daily charts below for the major Asian indices tell a more cautious picture, with the Nikkei consolidating, China and India both pulling back (India is down about 14% overall this year)

 

 

Nikkei (Japan), Hang Seng (Hong Kong), MSCI Taiwan, Nifty 50 (India) Daily Charts Courtesy of ANYOPTION.com   07 feb 13 1925 L

 

FOREX

 

A simple glance at any major currency pair involving the safe-haven USD shows virtually that every single one is at a significant support or resistance point, suggesting the above bullish trend for risk currencies is at a crossroads this week vs. the safe-haven USD.

 

The most important forex pair by far is the EURUSD, which alone comprises about 30% of all forex trade. Because the USD alone is a part of over 80% of forex trading, with the EUR the second most commonly traded currency, this pair indirectly affects most other currency pairs, especially those involving the EUR or USD. Thus the EURUSD pair is often a great representation of the strength of these currencies. When the pair is up, the EUR tends to be strong vs. most other currencies. When the pair is falling, the USD tends to be among the strongest currencies.

 

Note the weekly EURUSD chart below.

 

 

EURUSD WEEKLY CHART COURTESY OF ANYOPTION.COM  05 FEB 13 1735 L

 

The key take away point: the EURUSD has tried and failed to rise above the 1.3750 area, where it faces strong resistance from both its rising trend line (pink) dating back to June 2010, as well as its 23.8% Fibonacci retracement (horizontal yellow line with which the rising pink trend line intersects). It is now in a mild 3 week downtrend that is clearly part of a longer term downtrend that began in December 2009. Indeed this latest move lower may be the start of a second ‘lower high’ after the first occurred in October 2010, and that further confirms this long term EURUSD downtrend.

 

It’s really too early to announce the next leg down for the pair. The down trend of the past three weeks has been very mild, and thus could simply be a normal consolidation or rest period before further moves higher. The fate of this trend rests with the fundamentals that it will usually reflect over the longer term, in particular:

 

• The vicissitudes of the EU crisis
• Relative changes in yields for US treasury notes and bonds vs. German and EU bonds

 

 

COMMODITIES

 

Commodities tell a more mixed story.

 

The weekly chart for:

• Copper is slightly down but still near record highs, the same goes for grains.
• Crude oil is down for its second straight week.
• Precious metals are currency hedges and thus more reflect concern or calm about the EUR and USD than overall risk appetite, so they don’t really figure here as a market barometer at this time. However, they will reflect optimism about growth if that growth is deemed inflationary.

 

Other Market Drivers This Week: Key Calendar Themes and Events

 

See: The Coming Week February 14-18: Calendar Highlights, Themes, Key Market Movers at either www.seekingalpha.com orwww.globalmarketsguide.com or www.forexfactory.com

 

 

Key Indicators

 

Watch the S&P 500 daily chart. Pullbacks could ward of an overall risk aversion that alone could send the EUR falling, PIIGS bond rates rising and move us close to another bout of EU crisis.

 

EU Remains The Major Threat To Markets, So Watch These Developments Closely

 

Such a mature uptrend must eventually pull back once the fundamentals for doing so become compelling.

 

As we noted in our recent post Is a PIIGS Debt Restructuring Coming?, the four EU developments this past week noted above all suggest PIIGS debt restructure is coming. That’s short term bearish for the risk appetite in general, and the EUR in particular, as it means continued near term uncertainty for the EUR, rising risks of default and thus EU bank instability, which brought a severe market collapse this past spring. It also means more EUR printing , delayed interest rate hikes, and thus pressure on the EUR after its long run higher that is just beginning to reverse, and could easily retrace 5% – 10% before hitting long term support seen this past spring and summer.

 

 

DISCLOSURE & DISCLAIMER: AUTHOR SHORT THE EUR FOR PERSONAL PORTFOLIO. 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