Who's Laughing Now?
Submitted by Nic Lenoir of ICAP
We will start our market update with Greece's 5Y CDS market. The chart does not look like anything that could have a happy ending. Greece has come up with a plan to reduce the deficit which experts believe a) may not be enough b) will hard to achieve. The market obviously did not buy it either, and we have not really seen a wave of approval around Europe. If Greece wants to further they will have to start cutting entitlements and will face strikes which won't help the problem, so it leaves us most likely with some form of loan or bailout. We stick to our original thought that the EU won't let the IMF step in on their turf as it would be too humiliating, especialyl since this is the first harsh economic test for the union. The problem is that left holding the bag would probably be Germany (there are not that many candidates around the EU that can step in and help Greece, especially with Portugal and Spain waiting in line!). No wonder that today the German CDS was trading 8bps wider. As mr. Almunia said: in the EU there are no defaults! That does not bode well, because bail out or not, the problems of the EU are only beginning.
My first major target for EURUSD if we break through 1.3740 (which we are bound to do even if we managed to bounce here for a short while) is 1.14. We see that on the 180-minute chart we have bullish divergence here, but it appears the channel support is not until 1.3667. We are also very close to a cross of the 50- and 200-dma which would confirm the bigger picture bearish trend. Any bounce to the 50- or 200-dma should be sold here.
The other major funding currency with the USD is the JPY, and it's no wonder that in this risk averse environment the JPY shows a lot of strength. As can be seen on the EURJPY chart the market broke support at 127, we are testing the C=A at 122.79. AUDJPY is coming very close to breaking support around 76.30 (tested it earlier in the session). A close below would confirm more selling to come. There is a risk that at the open in Asia Japanese retailers will rush to cover more carry positions fueling the move further. We did point out the madness of Austria, Nigeria, or Venezuela, issuing bonds in USD to benefit from the greenback's weakness. Well hopefully they covered the FX position by now! I wonder how Hugo Chavez feels about devaluation right now... funny hu?
Equity markets are obviously under pressure. A client pointed out we must be close to the lows for the near term, because spain was down 6% at that point. Another way to look at it is that the IBEX was up at the highs almost 100% since last March in a country with 19% unemployment. We had recommended selling the Dax 2 days ago at 5,725, and we see 5,389 as the downside potential for this move. The 100-dma should remain resistance even if we bounce after reaching our downside target. The S&P future has a downside target of 1,051 for the near term. We see on the hourly chart that there is no bullish divergence here, and even if we bounce to test the resistance at 1,077 there is a good chance we see the downside target before we can see a proper bounce to our medium term sell zone 1,111/1,117. I stick to my view that the weekly charts indicate a possible major top in place in January and our next big support after 1051 will be 950.
Commodities are selling off with risk. Gold has broken its uptrend channel here and even though we could get a bounce here as the hourly RSI-21 is down at 16, we think the market will go test 1,008/991 which is the major support. If that doesn't hold we won't consider longs until 750... Copper broke its channel since March 2009 last week and has moved lower aggressively. We are still $20 of the first major support at $267. The only commodity really escaping the blood bath is Lumber, and we keep favoring this market ever since we broke out of the multi-year wedge at $200. Having missed the entire commodity rally since 2000, it is not really surprising to see Lumber outperforming when the entire sector is under pressure!
The big question coming out of this whole thing could be resurgence of the deflationary argument. Demographics will have a very deflationary impact in the the years to come, and combined with the burst of a 30Y credit bubble, downward price pressure should be massive. A very mainstream view among investors has been that inflation out of Asia and commodity price increases could actually trigger an inflation spike across the globe (with Asia starting to export inflation rather than deflation) which would send bonds tumbling and the USD collapsing. But at this point, we think the question is still out there whether a value-destroying inflation or deflation will win the fight. We have been leaning towards deflation to be quite honnest. Central banks in the US and Europe haven't even started withdrawing liquidity, and risk is already tumbling. China's bubble might be ready to burst as they started increasing bank reseves and curb lending only modestly, and Australia is already pausing. The path between the two evils is very thin and we won't walk it for long, that is the only certitude. Trading volumes will keep shrinking and volatility will keep rising until we decide which way we are headed or we are forced in either direction. I don't think in this context that NFP tomorrow morning will have much impact as long as we don't hear anything meaningful out of Europe. Combination of both a positive surprise on unemployment and some sort of European resolution is what can make us bounce to our sell target at 1,111/1,117 for S&P futures.
Good luck trading,