Choppy day as euro sells off

A marginally negative day in risk today, as a light day of news and data led to choppy and low-volume markets. FX saw more vol than equity, however, as the hung parliament in Australia and a negative surprise in Germany’s flash manufacturing PMI weighed down on currencies.
SPY finished the day down a fractional 0.38%, while extending its breakdown through its channel support line and finding intraday selling at its 55d. Volume continued to lag, and though it cleared near the LOD, the equity market likely won’t find significant volatility on either side until after Labor Day. I remained positioned short the market, however, and my bearishness is encouraged by the continuous resistance the market is finding at its 55d and channel support trendline.

The US Dollar Index is showing some significant technical developments, as it comes up to test both the 38.2% Fibonacci level from November 2009 lows to June 2010 highs (pictured) and 38.2% Fibonacci level from June highs to August lows. After finding a bid at its 21d, DX has turned back upward in a nice curved pattern and is honing on challenging its declining 55d. A breakout through this MA should send USD flying again and bring back the recoupling trade, as bearishness in risk would breed bullishness in USD. I expect a little bit of a selloff in the dollar at the 55d level, if not sooner, as it is sitting at recent highs, but I expect any selloff to be short-lived, and as open interest is turning upward again, the USD should find some major strength again very soon, particularly against the euro.

Crude continues to selloff as it extends its breakdown through the symmetrical triangle I mentioned a little over a week ago. A combination of a strong USD and weak growth data globally is weighing down on oil prices and the charts suggest a large downside move is just beginning. The $69-71/bbl zone has offered some strong support in the past year and crude may find some bids around there but I expect it to challenge and eventually break the 38.2% Fibo level around $69/bbl, which should trigger some major selling if and when.

German flash manufacturing PMI came in early this morning at 58.2 vs 60.5 consensus, providing a bearish sentiment to the euro. Although services PMI beat for both Germany and the Eurozone, the below-estimates manufacturing PMI for Germany & the Eurozone (as well as composite Eurozone PMI) weighed down on euro crosses, particularly against the carry funders USD & JPY. The EUR-USD LIBOR spread is still wide but in the current risk-averse environment, continued euro funding pressures could be more bearish than bullish, as instead of representing the effective rate hike from EONIA ticking up in a liquid funding environment, it represents the effect of the liquidity extraction in a risk-averse environment focused on growth slowdowns. If USD LIBOR reverses back higher, which I expect if the USD continues to rally, then the LTRO roll, which catalyzed the EONIA and EUR LIBOR rallies, could turn out to be a short-term gain/long-term pain type of event, similar to hawkish Fed policy in summer 2008 catalyzing the contraction in credit that led to the financial crisis (catalyzed, not caused—inevitability was definitely there). EURUSD broke its 55d today, and is still selling off as Asian trade begins, but is approaching its 50% Fibo retracement around the 1.26 handle. I expect a bounce around there in the short term, but a fresh breakdown through that level will most likely trigger me to add to my EURUSD short. Confirmation from a breakout in the US Dollar Index would be welcome, and further support from deteriorating economic data next month would be the icing on the cake.

EURJPY is down huge as well and back to around July lows. If EURJPY holds the 107 level (especially if JPY finds some selling soon—more on that later), it could trigger a short-term bounce in other euro crosses as well. But when this thing breaks down, it could be headed back to summer 2001 lows around 100, almost 800 pips from current rates.

USDJPY sold off on the risk aversion today, showing that the yen still is the king of risk funding. It is still stuck in rangebound trade, but the 30m chart shows a possible descending triangle developing. A breakout (which would also correspond with a 21d breakout) should send it challenging the 87 handle. However, it is currently sitting near 85-handle support and threatening a breach of that level for the millionth time in two weeks. It is still trading off rates and USTs (particularly the 10yr tenor, which has the highest correlation with USDJPY) are very overbought, so I’m looking for a fresh, unstretched pattern to develop in rates before trying to go short USDJPY. 10yr Tsy rates have been plunging more because of MBS market dynamics than deflationary risks necessarily, as the Fed’s MBS purchases lead to massive influx into Tsys from large MBS holders for duration hedging. The first wave down in rates in late spring caused a big refi boom that led to a positive-feedback reaction in rates, as duration hedging led rates even lower, leading mortgage rates lower, requiring further duration hedging, ahead of Fed demand, which required even more hedging. As rates are oversold and the refi boom and QE 1.5 are now priced in, I expect a short-term bounce in rates, though I expect them to test 200-220bps before everything is said and done, as deflationary risks take center stage from MBS dynamics. As far as how this relates to USDJPY, I still stand by my call for a short-term bounce to 87-87.50 before a plunge back to 85 and a breakdown through. No money on the line so take that scenario for what it’s worth.

The hung parliament in Australia led to a large gapdown in the Aussie, which pared its losses quickly, but found some selling pressure after risk turned down later in the morning. AUDUSD remains below its 200d and is perched right at the 0.89 S/R level. No obvious pattern developing on the charts, besides a possible falling wedge on a 30m, so the key level I’m watching is the 0.885 support level. If this gets breached, I expect AUDUSD to sell off pretty sizably. I will probably add to my short on a breach of 0.885, but if risk finds a short-term bid like I expect, it could be a week or longer before we see AUDUSD challenge 0.885.

CADJPY sold off almost a full big fig today on the back of risk aversion and declining oil prices. Not much to say about this cross beyond that as far as today’s action/data, but the longer term picture shows that it is challenging a very significant S/R zone after making three failed trips to the 55d in the last two months. If the 80-81 level gets taken out with volatility, then this cross could sell off big and take crude prices (and many carry trades) with it. Be careful, however, as a sustained bounce in risk could send this cross flying more than almost any other. The key is for CADJPY to remain below its declining 55d—a breakout through that MA could send it soaring. Presently, the market isn’t exhibiting a clear risk appetite/aversion picture, and volumes are low ahead of Labor Day. Once September rolls around, we should probably get a better idea of market dynamics and I may position myself one way or another in this cross (likely bearish).

An interesting chart from Citi is presented below, showing the US 10yr yield vs Citi’s US economic surprise index and the S&P vs Citi’s US earnings revisions index. As expected, the 10yr yield tracks economic surprises and equity market its earnings revisions, quite well.

There is a divergence, however, as companies beat earnings in the face of downside macro surprises. Citi contends that the decoupling is due to high operating leverage allowing firms to turn nominally small but positive growth into significant earnings. However, if the double dip continues to take root, particularly if August ISM has a poor print, the high operating leverage could end up doing more harm than good, just like it killed earnings back in 2008 as growth declined and the leverage amplified it. There is always a Goldilocks situation in between growth and decline, in which equities decouple from bond yields because of leverage juicing marginally positive data to beat the estimates coming from the negative first derivatives hurting bonds. However, this resolves in the decline killing positive earnings surprises as the leverage amplifies the selloff. Goldman Sachs has recently been pushing for defensive strats and recommending positioning toward lower op lev names. It will be interesting to see if leverage ends up hurting after all.

My trades so far have been performing quite well, and so I am raising/lowering my stops on these positions to lock in some gains. Please take note of the modifications to the stop levels in all of these trades. Because the timeframe for these trades is quite long, I don’t expect these stops to be hit and these represent last-ditch position downsizing levels.

OPEN TRADES

Short EUR/USD | 1.3120 | stop 1.2915 | +485 pips
Short AUD/USD | 0.9175 | stop 0.9100 | +275 pips
Short GBP/USD | 1.5985 | stop 1.5810 | +490 pips
Short /NG | 4.485 | stop 4.510 | +8.87%
Short /ES | 1113.00 | stop 1100.00 | +4.45%
Short /CL | 76.25 | stop 76.50 | +4.51%

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DISCLAIMER: Nothing contained anywhere in this commentary, including analysis and trade ideas, constitutes or should be construed as investing or financial advice, suggestion, or recommendation. Please consult a financial professional and do due diligence before engaging in any purchase or sale of securities.

Comments

[Sudden Debt]

The euro actually went down today just like all the markets did because of the fear of American new housing number that will be released today. And nobody expect them to be good.

ps: -0.19% isn't a sell off

[newstreet]

Looks like the Yen needs to spike higher before it can reverse.

[DavidC]

We've also got some POMO today - won't that (depending on the size) be good for the stock market?

I'm getting so confused now. I cut a short position (with a small profit) on the Dow yesterday afternoon because I've got so used to the shenanigans on any downward index moves, and the damned thing carried on down!

DavidC

[RoRoTrader]

In the context of the current POMO it is possible that offical interventions may be forming half-lives much like the accelerated interest cuts in the early days of the finacial criss began to have less and less impact.

At some point the 'market' will ask the question; do these peopel really know what the fuck they are doing? Probably not is the answer that may be creeping into the broader psychology at this point.

[dan22]

No More Austerity Measures, Greek Government Says

[RockyRacoon]

Thanks for the article. An example of the markets going in disjointed directions.

The herding crickets/cats analogy fits.  As does, "More chaos than a wheelbarrow full of toad frogs."  It's tough to TA one's way out of this sort of information.