EURUSD v Debt crisis

Over the past couple of weeks, with the latest leg of the on-going European Debt crisis hotting up, I have heard from a number of traders telling me that the EURUSD is about to collapse, a view which I must admit I have had some sympathy to. However, despite the market throwing the proverbial kitchen sink at the troubled Euro, it has once again seemed to defy the wishes of many and shown remarkable resilience.

I decided to see whether there has been a decent visible' correlation between heightened European Debt fears or not over the past year.  The chart below, shows the EURUSD (top), versus Spanish 10 Year government bond yields (bottom). - What seems apparent is a lack of any visible correlation between panics on Spanish debt (yields rising) and the value of the EUR versus the USD over the past year. -  During the summer panic the EURUSD remained sidelined in the low 1.40s, during the October - December Panic the EURUSD started and finished in the low 1.30s, but did spike up to over 1.4000. It would seem that the damage to the EURUSD tends if anything to follow in the wake of action taken to allay the panic. The current panic, whether it is over or not, does seem to be following along similar lines so far, with the currency remaining resilient just above 1.3000.

The PIIGS and Risk aversion - The sequal.

Concerns over European Sov Debt continue to rattle these markets. Irish 10 year yields are pushing close to 9%, to put some perspective on that just two weeks ago they were below 7%. The Irish contagion has spilled over to other PIIGS as CDS prices have risen strongly for Portugese, Spanish and Italian govt bonds. Meanwhile traditional safe-haven currencies USD, Yen and Swissy are outperforming the Euro and the risk orientated currencies such as the AUD. - Stocks have been wavering through the week, however overnight futures markets have seen heavy losses, and the risks are growing of a much deeper setback. The chart below is the SP500 e-mini futures over the past year. I have highlighted strong similarities between the period Dec 2009 to May 2010, and the period over past few months, the likeness is almost uncanny. - If history were to repeat itself here, (or more to the point rhyme), then things could start to get very ugly. The runaway train which was the SP500 last week may now be getting ready to come of the rails.

Something for the weekend:
Here in Britain, these rain-swept islands perched off of the North-West coast of Europe, we have generally been deemed largely irrelevant in the great race into space. The first country to send anything successfully into space were Germany, unfortunately for us in the UK, we were the intended target, with most of Germany's V2 rockets falling back from space and on to London. Since then the US, Russia and China have all managed to send people into space, plus the odd dog and monkey. We did try sending a probe to Mars a few years back, but we don't think it ever actually got there. -  Finally however, I am very proud to report that Britain finally has a space first, something which has been achieved at a mere fraction of the cost of the many Billion Dollar programmes achieved by other nations. Britain has become the first nation to put a paper plane into space. The story can be seen by hitting this link.  -- So lets hear it for British genius, ingenuity and inventiveness, and from now on, whenever you think of nations pertinent to space exploration, please remember to include Britain very firmly on that list. 

Have a great weekend .........

SPAIN IRELAND V SP500

I will keep this short and sweet today... Spain Credit Default Swaps are soaring, as have Irish CDSs been. In recent weeks Greece and Portuguese CDS have soared. The SP500 has shaken these off so far bolstered by QE, it may continue to do that, but I can't help thinking that a lot of good news is now priced in, whilst new global concerns may start to weigh, particularly as Spain is a much bigger fish than either of the other three. The charts below shows Spain and Irish CDS versus the SP500 over the past year, I have highlighted previous periods where CDS prices started to soar and how the SP500 reacted at the time.

Likely to remain volatile into next week. + US 10 Year + Is Greece hotting up again?

The US equity markets continues to behave in a volatile nature, this is not surprising given the weight of news and data over the next week. A QE story seems to hit the wires about every 5 minutes, it appears that opinion remains strongly divided both within the Fed and outside. My call is that Bernanke, being the sly old fox, will pander to both sides, perhaps not doing as much as the most extreme expectations, but none the less providing a strong boost, but within that also allowing flexibility for the future so that of he needs to hit it heavy and hard he can, or if he needs to ease back he can. - I do not expect the issue to actually be resolved fully next week, thus this will likely remain an on-going theme for the next several months, adding to increasingly volatile markets. I do not think much, direction wise, will be resolved until next week at least, but clearly the news will have the ability to slice a chunk off of the market, or give it an extra boost, which is why we are seeing increasingly volatile short-term action.

Moving on to US 10 Year yields. This is obviously a central theme in the on-going QE debate, since these are likely to be one of the main tools used by the Fed in the QE operations. However, an awful lot has been priced in on these, and in the past few weeks some of the froth has started to disappear from the 10 year t-note futures markets: Yields have seen a decent pick-up, rallying almost 40bps from the low 2.30s to the low 2.70s yesterday. I had been expecting this to move lower towards 2.00%, however whilst I do not rule this out for a later trade, short-term it looks like a low is in, and the risk of a rally towards the low 3 handles is a real possibility in the next few months. The first chart below shows US yields over the past couple of years.

The chart above shows how the yield has been forming a 'Falling Wedge' pattern in recent months, whilst momentum as measured by the 10 day RSI has been diverging upwards. The past couple of days has seen a breakout from the wedge, the yield may comeback to re-test the top of the wedge, but the risk is that it holds and moves higher. - The 10 Year t-note continuation future chart is also supporting these assertions. The top chart below shows this on a weekly basis. A couple of observations which I have highlighted:

• Firstly the strong similarity between the recent price and momentum action and the price and momentum action at the interim top in early 2008, both highlighted within the mauve ellipses. Note the sharp correction led to an extended consolidation, after which the main rally re-asserted itself. 

• Secondly the similarity between the bigger picture price action and the next chart below which shows Gold weekly 2006 - 2010, in particular the price behaviour as highlighted by the large red ellipses on both charts. On both occasions the breakout of these large patterns led to strong dynamic rallies. In the case of the Gold the rally eventually led to the Gold price being well overbought in late 2009. This saw a sharp correction followed by consolidation, eventually however the rally in Gold, as we know re-asserted itself.

The market is likely to see some rebound I think before and possibly around next week's news, however the move to higher yields could be a theme in the next few weeks.  Will this affect stocks? I am not sure, historically these markets move inversely, however the relationship between these two has not been consistent in recent years. However, if stocks were to suffer a sharp drop, then it is likely that bonds rally and yields drop, thus if the above scenario above were to occur, it is likely it would happen against a steady or rallying stock market environment.

Finally with regard to Greece; there has been a lot of negative talk hitting the wires these past couple of days. One theme seems to be how, with economic conditions weaker than expected (not helped by the EURUSD recovery), tax revenue is coming up short of projections in parts of Europe, and as a result countries struggling with high deficits are now confronting the prospect that they will miss the budget deficit targets forced upon them this year. In the past couple of days things have started to stir in Greece whilst Ireland has had mounting issues in the past couple of weeks. The charts below show the 5 Year CDS for Greece and Ireland over the past 6 months, below that is a chart of the SP500 Index and the EURUSD. I have highlighted the two prior occasions when the 5 year CDS prices moved up sharply in the past 6 months, and how this saw sharp drops in the SP500 and the value of the EURUSD. In addition I have placed emphasis on the action of the past week. - If this whole Euro Sovereign Debt issue were to explode again, then the above analysis is likely to be wrong on the T-note, as US yields should drop as a safe-haven bet while equities would once again probably turn ugly. 

 

Some thoughts on the SP500, EURJPY and Risk-on. Plus RBS trade idea.

US equities took a breather yesterday, and though I believe daily charts continue to support the recent bullish breakout, the failure to make a meaningful assault on 1130, shorter term momentum divergence patterns, plus rather poor volume, all hint that we may see some further consolidation and possibly warrants a little caution.

The Eurostoxx 50 has broken above the upper line of the symmetrical triangle which I referred to in Monday's post (see here), though thus far it is balking at resistance at the Mid-May and Mid- June highs at 2793.5 and 2787.5, these levels may prove pivotal, and until they are broken, a period of consolidation may ensue below these pivots.

With regard to the risk-on trade possibly coming back into favour, I first referred to this in a piece a couple of weeks ago (this can be seen here). Since then the aversion to the PIIGS countries has strongly receded, the large July funding issues have been overcome, CDS prices have dropped significantly, and the spread of PIIGS bond yields over German Bond yields has eased for all countries but Greece, though even the Greek spread has settled down into a range. The charts below show the 10 year v Germany yield spreads for the PIIGS since the start of 2010. (CLICK ON CHARTS TO ENLARGE).

Another measure of risk aversion has been the EURJPY fx cross. The EURJPY dropped sharply earlier this year as the flight from the Euro and risk took hold. Over the past couple of months this appear to have been forming a base, and in the past 24 hours it has attempted a push above the upper boundary of this basing pattern (Rounded Bottom Pattern). The top chart below show the bigger picture of EURJPY over the past 3 years, highlighting the 2 periods of  'Risk Aversion'. The lower chart is a close-in look at the past year.

One note of caution: I keep alive the possibility that this apparent bottoming process, with regard to risk, could morph into a new bearish phase. - Though I do not favour this outcome, as of yet none of the major risk-on trades have cleared or significantly cleared key pivotal or psychological levels. For example 1.3000 on the Euro is clearly a key psychological level for the market, more significantly the sharp drop following the announcement of the Greek bailout occurred from around 1.3100, I also have some key levels around 1.3100/1.3150 which I consider pivotal. The above mentioned Eurostoxx levels are pivotal as is 1130 on the SP500, many other risk-on trades remain close to key pivotal levels but have yet to have made a clear break. 

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Finally a quick look at an individual Stock trade idea. RBS has been a bit of bellwether for the Financial Crisis over this side of the pond. The top chart below shows the Weekly performance since 2006. I have highlighted a possible Ascending Triangle pattern formed over the past couple of years, though this is not yet complete. The chart below that shows BT (British Telecom) for the years 1999 through to 2007, this was a bellwether stock for the Telecoms and IT crash of the early 2000s. I am trying to show how RBS is evolving in a similar way to how the BT price evolved as a base in the years following the Telecom's crash.  
(CLICK ON CHARTS TO ENLARGE).

Looking closer at the basing phase on BT (See chart below); when the price broke above the triangle top, after a lengthy period of consolidation, the stock eventually climbed towards the triangle target and then the base of a significant consolidation zone, - before eventually falling away.

The next chart (see below) shows a closer look at RBS. The price behaviour is similar, and may portend a similar evolution to the BT chart. However there are two significant differences: Firstly the RBS 'Ascending Triangle' pattern is potentially a more bullish pattern than BT's 'Symmetrical Triangle', since resistance at the top of the 'Symmetrical Triangle' pattern is pushing lower, whereas this does not occur with an 'Ascending Triangle' pattern. - Hence any RBS breakout may be more bullish than the tortured breakout which occurred on the BT chart: Secondly, there is a large 'vacuum' of resistance above the RBS triangle which occurred as a result of the price downdraft in Oct 2008. - If the RBS price can clear £0.72 then £0.85 it could see the opposite effect of the downdraft, whereby the price rises rapidly (though not as rapidly as the decline).

Of course the above is all largely academic at this stage, and will remain so until the top of the triangle pattern at £0.60 has yet to be broken. The current price is around £0.50 and still £0.10 points shy of this key level, so it has some work to do to get there. However, I like this trade as it provides a potential nice Risk/Reward. The downside is £0.11 (stop below the recent low). The upside target, if it breaks £0.60 (where one could also add), would be £1.07 for the Triangle target, making a gain of £0.57 (Risk/Reward 5.7/1). Potentially though it could move much higher to the highlighted resistance lows around £1.40/1.50, or even to around £2.00 where the downdraft in October 2008 began, offering a much greater potential Risk/Reward.





 

Risk Off - Is it coming to an end?? + GBPUSD FX update.

Over the past few weeks I have outlined a number of possible bearish scenarios, and more recently I have posted some possible more bullish outcomes. The market has now taken us to a neutral/pivotal zone where direction is likely to be determined by which ever side of this zone makes a solid breakout. I believe 1070 - 1100 defines this pivotal zone for now. - In the meantime I have outlined two further pieces of analysis which argue both the possible bearish scenario and make a case for a more bullish outcome.

Firstly I have decided to look purely at the trend, as defined by the direction of highs and lows at reaction points. As the chart below shows, the past 2 months has seen a series of lower lows and lower highs since the end of April. This simple analysis supports the notion that the SP500 may have entered a downtrend in the past 2/3 months. - Until and unless 1130 is exceeded, this would suggest the odds favour a move to lower levels.

With regard to the more bullish possible outcome: The recent risk-off episode appears to have largely abated over the past couple of weeks. Stock markets have rallied, European currencies have rallied versus the USD and some of the periphery European yield spreads versus German yield spreads have eased. I have noticed looking at a number of charts, strong similarities over the past couple of months with the previous risk-off episode at the end of 2008/early 2009 in the wake of the Lehman's collapse, albeit generally on a much smaller scale. I will highlight this with a series of charts, in these charts I have defined the Post-Lehmans risk-off period as 'Risk-off 1', and the more recent period in the wake of the ratcheting up of the Greek crisis as 'Risk-off 2':

Firstly - Equities via the SP500 Index. (Top Chart) , UK FTSE (2nd Chart)

 

Then via FX in the form of the USD Index (Top Chart), AUDUSD (2nd Chart), AUDJPY (3rd Chart), EURJPY (4th Chart).

This can also be seen in may yield markets: German 10 year yields. (Top chart), US 10 year yield (2nd Chart), Spread of Belgium v German 10 Year Yield Spread (3rd chart) and 2 Year German Swap Spread (Libor v Gov yield) (Lower Chart),

 

The comparisons are not exact, and clearly other factors particular to each asset class or currency have their own effect. For example the USDJPY has behaved very differently, and commodities have also not shown a similar pattern. but by and large there is a strong similarity across a number of markets between the 6 month period following the Lehman collapse, and the past 2 and half months in the wake of the Greek crisis.

What does that mean going forward. Personally I believe in the short-run (over the summer) I guess it favours further reversal of the flight away from risk: In other words further recovery in stock markets, further USD weakness, and a slight backing up in longer yields. Beyond that the outlook is cloudy, though I struggle to see how markets could remain buoyant in the face of strong deleveraging headwinds.


Further to my GBPUSD update yesterday (That analysis can be seen at the bottom of yesterday's posting by clicking here) . The currency pair surged further yesterday, and the odds still favour some more upside, however it is likely to face some tough resistance around 1.5500/50.  This is where there some old highs from April are lurking, and is just below the 50% retrace of the downtrend which began last November.

SP500 + EURUSD

Yesterday's strong sell-off took US equities down to the support lines for late May early June. Of the major US indices only the S&P500 managed to make a slight new low for the year, most other indices just managed to hold their lows (for now), including the Dow Industrials & Transports, the NYSE composite, Russell 2000, and the Nasdaq. In Europe the FTSE 100 managed to hold the lows by a whisker, whereas most other Euro markets are well above their lows from the height of the Euro Sovereign Debt crisis. With regard to US equities, we are right on the pivotal point, for the third time in the past 5 weeks. A good friend of mine use to say rather crudely about key pivotal market levels, that price action has to 'Lubricate to Penetrate'. I believe that describes what has been occurring these past few weeks, with next week or so likely to determine whether penetration does actually occur. One slight note of caution however for the bears (of which I am one at the moment); quarter end is upon us, the key payroll data is due,as are ISMs etc, plus the extended 4th July weekend break. Add the fact that this comes on top of an already hefty 8% decline in the past 7 days, and it would not surprise me if the market take a breather allowing for some consolidation, if not from here, then perhaps from slightly lower levels.

With regard to the EURUSD I have talked to a few people who are frustrated with the failure of EURUSD to decline alongside US share indices this past week. This leads me to question whether the correlation between the two is breaking down. Below is a set of charts showing the SP500 over the past 5 years together with the EURUSD , and below them a chart of the 60 day correlation during that time. My reading of this (and I am no stato, so it is really a rather amateur reading), is that the correlation is generally rather poor, veering between periods of high correlation and low correlation but with no real consistency.Further to this I have looked at the 60 Week correlation going back to 1990. And this shows an even less consistent relationship, and if anything the periods of high correlation have tended to occur at times of Equity and EURUSD strength.
So with no real evidence of a link between US equity index performance and the EURUSD historically, why the obsession with looking for weaker EURUSD when US equities moving lower? I have a view as to why this might be, it may be right or it may be utter nonsense, but here goes anyway: The 2008 sell-off in Equities and EURUSD was a complete flight from all risk, and since both Long Equities and Long EURUSD were long-held risk trades at the time, their correlated move was not surprising. The recent move lower in stocks at the end of April, was in part triggered by fears of a full-blown Euro Sovereign Debt crisis, this itself was causing a flight from the EURUSD.

However over the past couple of weeks, I believe it is has been different. The weakness in equity markets is probably due to fears of poor US economic prospects (Double dip recession), not as a result of a Bank/HF deleveraging and consequential risk flight, nor as a result of a heightening of the Euro Sovereign Debt crisis. Therefore since the reason for this move would be a re-evaluation of US economic prospects, that should not be supportive for the USD going forward. On the other hand EURO economic prospects have already been massively downgraded as a result of the Euro Sovereign Debt crisis. -- Also, since an equity sell-off is leading to flight from risk (though not on the scale of 2008) it could be argued that this may actually be supportive for the EURUSD, since in 2007/8 risk was long EURUSD, whereas now I would guess risk is short EURUSD.

Shorter-term a break (and hold) through the 40 day moving average @ 1.2323 will be supportive for the EURUSD, and a break and hold over 1.2400 would confirm an inverse Head & Shoulders pattern, which could potentially see a move towards 1.3000. - On the other hand a successful break of the mid 1.2100 area, could spark a re-test of the lows of early June. --- Saying all that, the EURUSD has limited upside in the bigger picture due to its on-going concerns which are likely to continue to weigh on it, and I believe will eventually lead to sub-par levels over the next year or two.