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. 

 

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.

TIPPING POINTS ???????!

Overnight markets across the board saw significant moves. Chinese equities dropped sharply, the various indices posted declines of around 4-5%, this has seen follow through in other Asian indices, though not as steep as the Chinese decline. In Europe the move has seen declines of around 2 - 3% thus far, and S&P futures are currently down around 1.3%. Elsewhere global bond markets rallied, leading to a further declines in yields, with the US 10 year yield breaking below 3%. It now appears that Japan, Europe and the US 10 year government yields have all broken key levels... Meanwhile the USD has posted gains versus the Euro and the USDJPY has dropped and is moving close to the spike low posted on the night of the Flash Crash. -- Also worth noting that European spreads PIIGS v Germany have continued to back up following recent declines......
I have posted a selection of charts showing significant markets and the current move in a wider context... FWIW, I believe we are possibly approaching the end of this corrective phase on equity indices, though until the lows of late-May/Early June are clearly broken, this still has the ability to confound me and prove me completely wrong.

EURGBP Overview and Greece getting going again !!!!.

Yesterday's GBP budget has been given an immediate vote of confidence by the Foreign Exchange Markets. Cable has rallied 2 Big Figs in past 24 hours, whilst Sterling has also seen strong gains versus the EURO. In light of this I am posting a EURGBP chart showing the long-term picture, (Note this was created yesterday with EURGBP @ 8306, it has since dropped to 8240). This shows a large topping pattern over the past 2 years (either a Reverse Symmetrical Triangle, or Double Top), this should create strong downward pressure on this pair going forward. - Strong support zone @ 8170 to 8230 held a first attempt earlier this month, and may check the decline again, however I would favour an eventual break through here towards the second major support zone around 7700/7780. -- Weekly Momentum studies are supportive, (See below). The weekly ADX is turning up from low levels with a negative DMI in the ascendancy, suggesting a bearish trend is establishing itself, whilst weekly RSI is only just pushing the oversold boundary, suggesting some way to go before becoming overextended, and MACD shows strengthening downforce.One further set of charts I wish to post is Greece 10 Year Yield CDS v the Lehman Share price (Inverted) over its final 2 years, the final period being Lehman's death spiral. Note: the strong similarity in the appearance of these charts, and also the peak of the Greece CDS from early May, pre-ECB rescue package announcement, is in danger of being exceeded. The chart below is last night's close, already today the Greek German Spread has widened 66bps or 9% on the day. Greece may be yesterday's story, but may soon become tomorrow's story if it carries on like this.....

Austerity measures the Vogue in Europe + Japan 10 Year Yield Analysis

Today's main event in the UK, is the new government's first budget, and one that they hope will re-assure markets with regard to the credibility of the UK's finances. However, I think its significance may be that it will be further confirmation of the reversal of the expansionary Fiscal policies of Western governments of recent years, particularly in the wake of the financial crisis and recession of 2007/8. European Governments have started already, in the case of the PIIGS they have been or are being forced into tough austerity measures, whilst the core Euro governments argued strongly at the recent G20 that deficit reduction is now priority Number 1, and Germany just recently announced a budget aimed at drastically reducing its own deficits. Across to the Far-East and just over a week ago the new Japanese prime-minister Kan Naoto spoke of a new 'Third-way' in Japanese economic policy, whereby deficit reduction measures will become a key leg of government policy. Elsewhere, in emerging markets economies, fear of inflation may be leading to stronger anti-inflationary measures, some commentators cite this as one of the reasons for the weekend's Chinese move of allowing its currency to strengthen against the US dollar. - The US continues to stand by its more expansionary fiscal policy of recent years, however the drive for tighter fiscal policies from Europe and Japan, alongside continued deleveraging efforts by consumers, increases the risk that deflationary forces may continue to exert pressure on asset valuations.

I will post one chart today, it follows yesterday's analysis on the US 10 year yield, whereby I stated that I believe the balance of risks favour lower yields, although as usual things are not that straight forward and we remain close to key pivotal levels which could lead to a reversal in yields. Today I am posting a chart showing weekly 10 year Japan government yields over the past decade (See below). Like the US 10 year yield, this sits very close to a major pivotal line, and today it has moved to within a whisker of this level (The close last night was 1.195%, the lowest close since 1.17% in Jan 2009). Also like the US yield chart, significant price patterns are exerting downward pressure on yields, price action over the past couple of years has led to the formation of a Bearish 'Descending Triangle', additionally price action since 2003 has evolved possibly as a multi-year Head & Shoulders type formation. - Since 2003, the support zone of 1.17-1.20 (my line in the sand), has held as support on numerous occasions, and is likely to be a difficult hurdle to overcome, furthermore rating agencies are watching Japan closely which may provide further support. - However, should this line suffer a clear and sustained breach, I believe that it would suggest stronger deflationary pressures ahead for Japan, though this time, it might not be Japan alone facing the threat of deflation.One final set of charts, unrelated to the above. It is the SP index in 3 charts. Top Chart is 1980s through to present day on a Log Scale. Middle chart is SP Index Mar 2009 daily. Lower chart is 5 minutes for past couple of weeks. Are there similar patterns forming across the 3 different time scales?? ,,,or perhaps I am just curve-fitting (Always a danger)? If the S&P bounces to around 1120ish, then falls through support around 1105/06, it may suggest something in this, though the likelihood is strong that I have curve-fitted...........

PIIGS, Ratings and the World Cup

I don't know if anyone else has noticed, but there seems to be somewhat bizarre correlation occurring with the World Cup and the real world, particularly with regard to a countries performance compared to their investment ratings. - This follows the disastrous spill by the English goalie 'Green' against the US, which echoed the disastrous spill by a British company with a 'green' logo against the US. -- Looking at the PIIGS countries' world cup so far brings home my point. Portugal, one of the pre-tournament favourites, struggled in a 0 -0 draw with Ivory Coast. Current World Champs Italy scraped a draw against mighty Paraguay. Ireland did not make the finals thanks to some handy work by the French, but former European champions Greece looked totally abject losing 2 -0 to South Korea. However, the big shocker was the defeat yesterday of hotly fancied current European champions Spain to Switzerland, a country with barely enough flatland for more than a couple of football pitches. Yet as Spanish government bonds spreads were once again sold heavily and spreads widened sharply, no doubt prompting fears of further downgrades, their football team was losing to the country with possibly the highest rated government bonds in the world. -- Meanwhile the top performers of the opening round of matches pretty well match the recent top performing countries bonds, Germany had the best result of the opening round, whilst the US and Japan, both countries where football (or soccer) rarely gets much attention, easily exceeded their expectations. And finally on a day when Chile looked very impressive in winning their first match, Moody's actually upgraded Chile to Aa3 from A1, 'you could not have made it up'.

Which brings me nicely onto the subject of Spain and Bond yields. Once again the spread of 10 year Spain has widened versus the German benchmark. already as I write this morning, they have widened 10bps on the day, and are now +42bps on the week. However, at the moment markets seem unphased with regard to this, and thus far equities and the Euro are onto holding strong gains made this week. I personally feel that this is like watching a Hurricane forming deep out to sea, which has the potential to be a full strength category 5 with heavy destructive capability should it touch land, however the way markets are behaving it seems they feel that it will probably never reach land. This suggests to me that either this hurricane will blow itself out, or there is too much confidence that its path will not veer onto a more dangerous course.

The chart below shows the widening of Spain v Germany and the divergence with the EURUSD fx rate over the past week.

EURO - Where next ?

I'm a bit tired, a bit poorer and slightly 'worse for wear' this morning, following a great day at the races yesterday. --- However, it served as a nice little reminder to me that form does not always count, no matter how strong a favourite a horse may be, even when running under ideal conditions. - I can apply that little metaphor to the market at the moment. Yesterday morning, having seen the spread widening of the previous day in Spain v Germany, and the Greek downgrade, followed by further huge spread widening, I was adamant that the Euro was going to get hit again. However, it found surprising strength, and I guess I should have put a little more faith in my own analysis of a couple of days ago, when I suggested that breaking above the short-term resistance at 1.2150 and closing over the 15-day moving average (1.2170), would provide a boost to the Euro. -- Hence I now find myself at somewhat of a juxtaposition. On one hand the spread widening of Greece, Spain, Portugal and Ireland has restarted with vigour over the past 2/3 days, but Italy has thus far been immune from this latest bout of worries, as have the core countries of France and Belgium. --- On the other hand, the technical break over 1.2150, and the hold of the re-test of this level yesterday favour further gains towards the 40-day moving average, which is currently 1.2544 (though this is dropping sharply and will probably be in the mid 1.2400s in a few days time). Yet, countering this, I view the move higher in the Euro as a correction in an on-going downtrend, which will eventually take the Euro much lower... ---- which Horse shall I bet on ???? Decisions decisions. I think I'll sit this one out for now actually, although my view fwiw is that as long as the core spreads stay calm, then the Euro could make some further gains, though that could change if Spanish spreads go into overdrive ---

Below are charts showing how the Spread of Spain v Germany and Italy v Germany have diverged in recent days.

Spain v Germany - Evening Star pattern on Hourly

Something to keep an eye on. The deterioration in Euro sovereign debt over the past week has been a stronger driver of the risk-off trade of the past few days, with the main focus being the spread between Germany and Spain. However the above hourly chart shows an evening star pattern formed during the past few hours. It is a signal suggesting the first sign a possible pause/correction in this uptrend, and should be watched for any follow through. Note, at this stage the trend remains higher, however a close through the rising trendline, and a lower close than yesterday could change this.

I would also like to note that some of the other usual 'Risk-off' signals, have been fairly relaxed during the most recent sell-off. USDJPY has remained fairly stable, Gold & Silver remain 'bid to old boots', and Libors appear very relaxed. I am questioning whether the 'Risk-off' trade may be due for another pause.

Payroll Day & Eurozone Spread Widening.

Today is all about US payroll numbers. its gonna be big,,, but how big.... that is the question..... The reason its gonna be big, as everyone knows is the census worker hiring. The average guesstimate according to Bloomberg is 536,000, however there is a large range from various analysts around this number ranging from the low 200,000s to the mid 700,000s. - I am always amazed that this number is given so much credence by markets, a number that is calculated using so many statistical adjustments, and that is revised so many times over the coming months, so much that its initial release is often meaningless, and yet it probably gets more focus in markets, and more initial trading reaction than just about any other data release on earth.

The markets over the course of this week seemed to have entered a period of calm, relative to action through May. The SP500 had its smallest daily trading range yesterday since late-April. EURUSD continues to gyrate in a spiraling downward fashion within its recent 1.2150-low 1.23s range. USDJPY has been gaining slowly on a less risk adverse environment, perhaps helped by the political situation in Japan, this may have helped calm currencies which reside on the other side of the carry, such as CAD and AUD. So it seems that near-term direction no wmay hinge on a number which is calculated using a somewhat contentious method, which is going to be distorted by a very heavy one-off adjustent, and which will be probably be revised several times over the coming months.

Meanwhile, it is worth a mention that periphery Europe spreads have been widening again over the course of this week. The Spain v Germany 2 yr spread has widened to 225bps and 10 yr spread has widened out to almost 190 bps, that is respective gains of 45 and 37bps over the past week. Other spreads have been widening too; Italy, Portugal, Ireland and Greece have started to rewiden, even France has widened so far this week from 26 - 39 bps, the largest weekly move since 1995. This may well be the early stages of the next phase of the Sovereign Debt crisis, with larger more significant European Countries becoming affected. -- Further to this I have posted a couple of charts below, the first chart is the 2 Year Spanish Gov Bond Yield weekly with 50 week moving average. In Technical Analysis parlance, this may have traced out a 'Rounded Bottom' or 'Frying Pan bottom' pattern, which could portent significant gains in yields in coming weeks. - Below that I have shown how a 'Rounded Bottom' pattern formed on Greek 10 year yields in the latter half of 2009, and how this evolved into the significantly higher yields (somewhat of an understatement) through this year.