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.

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.

My SP500 system passed its summer test. +. EURUSD and Spain worries.

Over the past couple of years I have been monitoring the performance of a 'Trend-Following' system which I created and which I have back-tested going back to 1970. The system faced a major test of its performance this summer, when equity markets went through a torrid correction and phase of up and down swings: Various moving-average indicators (such as the 50/200 Death Cross), and other signals such as the 'Hindenburg Omen' produced Bearish signals.Though my system came close to giving a bear market signal, it ultimately failed to trigger it and retained its Bull Market signal, which was generated in August last year. The system can either be 'Bullish', 'Bearish' or 'Neutral'. I first mentioned my system in a post on the 29th July (Can be seen by clicking here). The system, being a trend following system, is not used to give advance signals, however it does seem to be doing a great job of capturing the underlying trend of the market. Without giving too much away the system is a combination of moving average and trend strength, moderated by volatility and a stop-loss rule. The chart below is the SP500 Index on a Log-Scale from 1970 to 2010, below that is my Bull Marker/Bear Market signal produced by the indicator.

The following is a basic comparison of this system versus the 50/200 cross, Buy and Hold, and 3 year compounded Treasury Yield,I have kept it as simple comparisons. Thus as well as producing a far better return than all these measurements, the system had a much better ratio of winning signals to losing signals on the 50/200 day crossover method; my system had 75% of all directional signals producing positive results, versus 55% for the 50/200 crossover. 

 
As I said the system is trend following not leading, however it does provide a reliable guide to longer-term  market conditions.

Getting away from my system and focusing on the short-term outlook, I believe the SP500 may be vulnerable to some profit-taking. Last week's big news is now out of the way, the April 2010 highs having been hit, a great run-up for stocks since early Sep is now at a mature stage, and elevated concerns of the European Sov Debt crisis are re-surfacing, with all this I can not help thinking some longs may wish to take some chips off the table.  

EURUSD and the EUROPEAN SOV DEBT CRISIS.

Concern continues over the re-emergence of the European Sov Debt Crisis, this continues to undermine the EURUSD. Friday's post highlighted the weak daily structure of the EURUSD on the daily charts, the weekly chart also looks unfavourable for the EURUSD and suggests a possibility of deeper losses to come. I have shown a weekly chart of the EURUSD below, last weeks price action produced a 'Shooting Star' candle. I have highlighted previous 'Shooting Star' candles on this chart.

For the last couple of weeks the Sov Debt crisis has been bubbling under again, I focused on Ireland and Greece in a post a couple of weeks ago whilst Portugal has also been getting much attention. However now the Spanish yield spread v Germany is starting to re-widen and Spanish CDS prices are also pushing up towards their highs of the summer. The charts below show both of these over the past 6 months, technically they both appear to have broken out of a large triangle pattern, which suggests higher levels ahead.

The market, whilst paying lip service, has largely ignored the Greece, Ireland and Portugal woes in recent weeks, however if Spain starts to have problems, then it will have trouble ignoring this, the table below highlights the glaring reason why this would be so.

One final point on the EURUSD, the whole pattern since the June low may be starting to take on the appearance of a '3 Peaks and a Domed House' Pattern (see chart below). As I have mentioned in the past these are very rare patterns but can be extremely dynamic if they follow through. This is one to keep an eye on.

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.

Intraday Update

Further to this mornings' earlier post.. Spain v Germany has turned from + 10bps on the day at the time of below writing to -15bp as I write. It looks like the divergence below was in favour of the EURO, which is 100 tics higher at 1.2390.

Beyond that. If this morning's move can be sustained, I am leaning towards entertaining the possibility that we may have a more substantial EURUSD correction than I originally envisaged. The 2 charts below, show some price action which is indicative of my thinking. Though it must be borne in mind, that a) today's move is only an intraday move so far. b) one can not rule out another shake out creating a re-test of the low. I would also add that in recent weeks a potential multi-year 'Head & Shoulder' neckline was broken, which projects the EURUSD much lower, however, breaks of necklines are often re-tested, and this currently resides at 1.2710.

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 widens again. - May put a dent in Stock's rally.

The spread between 10 year Spanish and German yields have widened significantly today, reversing much of the recent narrowing over the past week. This may cause headwinds for the recent stock markets gains as there has been a rough correlation between this spread and moves in the US stock markets over recent weeks.

The charts below show this rough correlation. -- Note; last weeks widening in this spread also saw a widening in Italian and French spreads versus Germany, thus far Italy and French spreads have not re-widened, perhaps mitigating the effect somewhat, however if this widening gathers steam over the next few days it could a) spill over into other European markets. b) start to affect risk appetite and hence stocks.
- Also worth pointing out that Moody's has downgraded Greece again in past hour or so. http://www.zerohedge.com/article/moodys-downgrade-greece-ba1-a3-stable-outlookand rbeen stable.

Risk on ???

The 'Inverse Cup & Handle' possibility which I mentioned yesterday looks dead in the water, although at one stage last night it did look a good possibility but now its dead... --- Moving swiftly on, this morning it seems that we are moving away from risk-off -- at least for the next few hours/days.... The 'risk-off ' trade of the past several weeks has been characterised by several key features in various asset markets: - Strong declines in major global stock markets, interbank lending rates (Libor) rising, strong USD, JPY and Gold + weak EUR, German and US bonds making strong gains, spreads of Non-German European Bonds widening v German Bond Yields, to name but a few... - However, it appears this morning that a number of these features have turned/ or are turning / or are threatening to turn... Below is somewhat of a chart-fest highlighting these various markets.

Firstly - The USD Index - this has seen very strong gains in recent weeks, however it is running into a major resistance line. - In the bigger picture this is the Neckline of a huge multi-year Inverse Head & Shoulders pattern, in the shorter term however it is major resistance. - Additionally, there is significant divergence between gains in recent weeks and momentum as measured by the RSI and MacD indicator. Taken together this warns of potential reversal or consolidation.The EURJPY has been watched very closely as this has had a very strong correlation with the move lower on the S&P. At first glance this is showing less sign of reversing than some of the other markets, the downtrend is still strong, however RSI and MacD is diverging from this price action. - In addition Monday's low at 108.08 was an exact Fibonacci 76.4% correction of the entire entire rally from 2000-2008, and was also .06 ticks shy of 1.618x the move from Oct 2009 to the intermediate low in Feb 2010.

Pressure on Interbank lending seems to have eased over the past couple of weeks, the rise in Libor has been minimal or stopped altogether in the past few days, whilst Libor futures which had been moving in synch with equities until late May, has seen strong gains since then. This can be seen in the following chart.
Also note how spreads within Euroland v Germany have started to sharply contract. The following 2 charts show Spain and Italy 10 year yields v German 10 year yields.Finally equities. First is the IBEX. this has been particularly badly hit in recent weeks. However, there are signs signs that this may (and I re-iterate the word 'may') be turning. The recent low was within a whisker of the 2/3rd retracement of the March 2009 - Jan 2010 rally, momentum is bullishly diverging, and thus far the breakout of the descending triangle pattern is showing signs of a failure, which could see a reversal. Today and by the latest tomorrow, should shed some further light on whether or not this is a failed breakout. - If it is a failure, this should see the Ibex making some decent gains.

The next chart is the AUSUSD v the SP500 since late April. Yesterday I highlighted how the AUDUSD spot seems to have been leading the Sp500, if this is still the case and the AUDUSD manages to hold onto its strong gains of the past 24 hours, then this would favour a strong move higher in the S&P.


In conclusion. The above charts are posted as evidence that the risk-off episode we have been within over recent weeks may be due to correct. I am not going to commit myself to saying this will happen, only there is a lot of evidence piling up against it. I also do not say this as the end of the overall risk-off trade, only that we may see a few days or even a few weeks whereby the market is able to gain some stability. I will also point out some caveats; the moves of the past 24/48 hours could be minor corrective moves which have or will soon have run their course, in addition most markets or risk assets still remain close to recent extremes. Also I would have liked to see the USDJPY perhaps moving a little higher towards the high 91s. Either way I think the markets face a couple of interesting 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.