When I sat down to write my commentary on this week's trading all I could think was, "this should be a wild week". What's facing the markets are a number of calendar events and central bank events that are all culminating over the next five trading days, so the key theme I want traders to keep in the forefront of their minds and trading decisions -- risk management.
High risk alert--
Over the next 48-hours the price action of the Forex market, equities, commodities, and fixed income will all be under the direct influence of a major calendar event that I like to refer to as "end of quarter book squaring". Monday and Tuesday are the final two trade days of Q2 and that will be the very last opportunity for market participants like hedge funds, money managers, brokers, institutional traders, and participants in banking/finance to show some kind of a profit or to mitigate an unrealized loss.
Historical price action patterns and historical price behaviors show a repeated pattern of heightened volatility and extended periods of strong price swings the final 48-hours of each quarter. This is not a random coincidence but due to the process for how market participants close out positions, for profit or loss. The end of quarter price swings also repeatedly reoccur due to the continuous and varying degrees of money-flows and levels of liquidity that are moving in and out of all the financial markets as participants are squaring up, repositioning, or pre-positioning.
The strong correlation between currencies, crude oil, gold, the S&P 500, Dow Jones, and Treasuries dictates the high probability for intensified price action across the board as each of those individual markets affect each other as a whole. At least for the next 48-hours forget the charts, forget the multi-colored dissecting lines, all that junk is meaningless because the markets will be driven by fear and greed... just follow the money trail...
The end of quarter window dressing that goes on is driven purely by fear and greed -- fear that a money manager or hedge fund won't show a profit for Q2 or greed that a money manager or hedge fund can potentially show a bigger profit than expected in order to pad their fees and commissions. Many market participants are under intense pressure to show a profitable performance in order to make their quarterly statements look good and this means some of those participants will either take profit off the table, be forced to cover an unrealized loss, or to do some revenge trading to make that bonus or commission and to keep the phone calls from angry clients to a minimum.
I love the end of quarter madness because it shows how human emotions really control markets and drive price action. I recommend to most retail Forex traders to sit on the sidelines while the markets go through this process, especially for those traders who are too under capitalized to be in the FX market in the first place.
End of quarter trade plan--
Other than reducing the amount of margin I use for each trade position I won't be doing a whole lot different over the next 48-hours in terms of how I pick my entries and exits. That being said, I am starting the week with an anti-dollar bias until we at least get through the end of quarter book squaring event. In my trading career I've been through ten end of quarter events and based on what my experience shows me and on what historical price action shows, the dollar historically has a higher probability of weakening against the euro.
With the Forex market's tendency to repeat price patterns over and over again, I'm choosing not to fight against history or human behavior. Of course if crude oil, gold, and the S&P 500 make gains over the next 48-hours the dollar should be under downside pressure just from those factors alone.
After we get past this calendar event I may reevaluate my anti-dollar bias because we will be coming up on the 1-year anniversary of the market's monumental meltdown. It was just two weeks into Q3 last year that the Forex, commodities, and equity markets plunged from their historical highs... the EUR/USD, crude oil, and the S&P 500 all made their historical highs in tandem (not a coincidence) and as crude oil was the first to crack and sell-off from the $147 level, the S&P 500 tanked which took the EUR/USD from the 1.6000 level all the way to the 1.2300 level between last July and October.
I'm not predicting or expecting an exact repeat performance of last summer but after we get past this week's calendar events which include an ECB monetary policy meeting and NFP, there's really no way to predict what the markets will decide to do next. History will always repeat itself but at this point I am not seeing the market's sentiment move closer to the side of risk aversion as opposed to where participants have been in terms of maintaining a higher risk appetite.
Keep things as simple as possible, don't fight against the market correlations even if they appear disjointed at times but to just go with the flow, follow the money and when you do not have a clear view on where you think the market will go, sit out and protect your capital. The great Jesse Livermore once said:
"The game of speculation is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, the person of inferior emotional balance, or the get-rich-quick adventurer. They will die poor."
Fundamental events moving markets this week:
The end of month/end of quarter/start of new quarter are not the only calender events that will move markets this week. There are a number of fundamental factors that will come into play as traders attempt to determine the short-term fate of the euro, dollar, pound sterling, and yen. Underlying fundamental factors like inflation, deflation, monetary policy, employment, manufacturing, and the health of the consumer will all come into view by the markets.
The following fundamental factors hold the highest potential to move the EUR/USD and its correlated markets this week:
- Eurozone Consumer Confidence (Monday 0500 EST)
- Eurozone M3 Money Supply (Tuesday 0400 EST)
- Eurozone Flash CPI (Tuesday 0500 EST)
- US Consumer Confidence (Tuesday 1000 EST)
- German Retail Sales (Wednesday 0200 EST)
- ISM Manufacturing and ISM Prices (Wednesday 1000 EST)
- Pending Home Sales and Construction Spending (Wednesday 1000 EST)
- Crude Oil Inventories (Wednesday 1030 EST)
- ECB Trichet monetary policy press conference (Thursday 0830 EST)
- Non-Farm Payrolls and Unemployment Rate (Thursday 830 EST)
- Eurozone Retail Sales (Friday 0500 EST)
- US bank holiday (Friday)
There will also be plenty of central bankers from the Fed, ECB, BOE, BOJ, and SNB speaking this week. The markets are still ripe for market-moving verbal manipulation, do not get caught off guard because the central bankers may want to use the market conditions to their advantage this week to move their respective currencies one direction or the other.
The ECB and monetary policy:
At 0745 EST on Thursday the ECB will release their latest decision on their monetary policy for the key lending rate. At this point I see a no-change in their interest rate policy. The main reason I believe the ECB rate will leave rates at 1.00% is because Trichet has repeatedly said he's not cutting rates this month. Trichet could just be messing with the market's minds but his pattern of behavior in the past shows a much higher tendency for his rhetoric on interest rates to match actual monetary policy.
Remember what the ECB did to the dollar last Tuesday? In case you forget you can re-read it here. It only took a few comments on interest rates from the ECB to send the euro flying against the dollar last week. If Trichet wants to boost the euro again he can do it at his monetary policy press conference on Thursday.
For the past few weeks the Fed and ECB have worked well together to keep the EUR/USD in a relatively tight range. The purpose for this isn't anything I know but it doesn't matter, the evidence is clear based on all the verbal rhetoric and monetary policy actions by both central banks. The latest FOMC monetary policy event did not reveal a strong pro-dollar bias. I think their statement left the door open for market participants to continue selling the dollar when the opportunity presents itself.
The ECB has maintained a fairly consistent pro-euro stance recently. Could this change suddenly? Of course, but for now I'm adding the central bank and monetary policy factors as another reason for my anti-dollar bias because the recent trend between the Fed and ECB has been anti-dollar, pro-euro. Until the central banks change their bias, I'm not changing mine.
Trichet is pretty reliable when it comes to telling the market what to do with the euro. If Trichet wants the euro to keep gaining on the dollar he will paint a good picture of the Eurozone's economic, fundamental, and banking sectors. If Trichet tells the markets that deflation is not an issue and that ECB interest rates have reached their lowest threshold, that's his way of telling the markets to appreciate the euro and to buy it against the dollar.
If Trichet wants the euro to depreciate he will tell the market's the ECB is concerned about deflation, that interest rates can go lower in the future, that the ECB is going to monetize sovereign debt, that the Eurozone economy is going to contract further than previously expected, and that the European banking system is fractured.
I can't predict which message we will hear from Trichet but it won't be hard to figure out at his press conference. It should not be a mystery, Trichet uses less double-speak than Bernanke and it is very easy to read between the lines to decipher what he wants the market to do with the EUR/USD.
Treasury bonds and the US dollar:The past couple of months there's been a lot of focus put on Treasuries and the US debt market, and ever since the Fed announced it would buy up to $300 billion worth of debt, the Treasury/Dollar connection has received the full attention of market participants. When I see something on Bloomberg or CNBC about Treasuries and the US dollar I never see the commentator or analyst explain the relationship between the two.
I think it is important for Forex traders to get a grasp on the Treasury/Dollar connection because their relationship affects both the debt and currency markets in very specific ways. The currency market is not a single entity unto itself and one of the correlated markets which helps determine currency valuations is the US debt market.
Next to the currency market, the US Treasury market is the most liquid in the world. This means the Treasury market can easily handle multi-billion dollar transactions, they can absorb selling pressures while preventing wild price swings, Treasuries are easily converted and there has never been a default on US debt, to date. US Treasuries are considered to be the safest and least riskiest asset class used for investment purposes.
One of the big reasons Treasuries have a strong affect on not just the Forex markets but all financial markets is because they are made up of the two biggest components that drive risk appetites -- price and yield (rate of return). All tradeable financial market are just a space for speculators to seek a rate of return on their money. Some speculators want to get that rate of return as safely as possible while others want that astronomical rate of return. But the way it works is, the lower the risk, the lower the yield, the higher the risk, the higher the yield.
In order for market participants to trade in the US Treasury market they need to use the US dollar and in order for the Treasury to meet its obligation to its creditors they need to use the US dollar. The use of the dollar comes full circle from the moment the investor hands the US government his money for a predetermined amount of time back to the moment when the federal government pays their creditor interest and then principle when the debt obligation comes to full maturity. That factor alone is just enough to affect the dollar's valuations against currencies like the euro, pound sterling, Swiss franc, and yen.
The other key factor which causes the valuation of the dollar to change is also directly related to the yield of each respective US debt obligation. Earlier this year the 10-year note was yielding just 6bps above the 2.00% level and now the 10-year is yielding over the 3.60% level. That means the US government is getting a lower price for their debt and that it will cost the government more money to pay its debts. Right now the US government has a major deficit problem, public debt has skyrocketed and those factors are bad for the US dollar and are a strike against it.
Then when the Treasury prints money to give to the Fed to return it back to the Treasury in exchange for its own debt, the dollar gets a really big strike against it. In a
normal world this process of monetizing sovereign debt would be impossible but when you have the Fed and Treasury working so closely together with powers that are not even constitutional, they are like the Super Friends of the financial markets, they can just do whatever they want and nobody can stop them.
All Treasuries have a minimum denomination of $1000 and there will always be more supply than demand and that's another reason the Treasury market is so liquid and how multi-billions of dollars can move in and out of the market on a daily basis. This factor also has a direct affect on the valuation of the US dollar at any given moment of the trade day.
The other factor with the connection between Treasuries and the dollar is debt repayments... lets suppose you bought a $1000 debt obligation on the 10-year note at a yield of 4.00%. That means the government would pay you $20 every 6-months and then at the date of maturity they would return your $1000 in principle. The more debt that is supplied and purchased means the government has more debt to pay back which is bad for the dollar. Plus, the more debt that is supplied means the yield is higher and the government has to pay more to get less.
Dollars have to be printed to facilitate these processes and of course that is a big strike against the dollar. A market situation where Treasury yields are rising can be dollar positive but the cause for the higher yields is the key. If Treasury yields are rising because the Treasury is over supplying the market with debt, that is bad for Treasuries and bad for the dollar. Printing money is the purest form of inflation and when inflation rises the value of Treasuries falls.
Foreign debt holders like the Chinese see their investment in Treasuries erode when the value of their investment falls and the dollar weakens. Whenever inflationary price pressures pick up again in the future any foreign investment in Treasuries will devalue accordingly. Add the combination of inflationary price pressures and a depreciated US dollar and US debt looks pretty unattractive.
I don't want to over complicate this stuff but hopefully this sheds some light on why the Treasury market is so closely correlated to the Forex market and why movements in the Treasury market lead to movements on pairs like the EUR/USD, USD/CHF, GPB/USD, and USD/JPY. Even though I'm purely a currency trader I keep close tabs on the Treasury market because I think bond traders are very smart and well adjusted to the fundamental, monetary policy, and geo-political factors which move the markets.
Swiss National Bank interventions:Between March and as recent as last week, the SNB has gone on a quest to manipulate and devalue the Swiss franc. In the past three months there's been at least six open-market operations by the SNB and BIS to depreciate the franc versus the euro. The secondary affect of their open-market operations results in the dollar gaining against the franc and because the USD/CHF and EUR/USD maintain mostly an inverse correlation, the EUR/USD routinely moves lower during these interventions just for the fact the USD/CHF and EUR/CHF move higher.
Why the SNB is depreciating the franc--The SNB and BIS are most concerned with the valuation of the EUR/CHF and their main objective is to sharply weaken the franc against the euro. The SNB's motivation to devalue their own currency is about as simple as it gets... debt holders in Europe, especially in Eastern Europe owe Swiss banks money and they want to get paid, bottomline. The Swiss are good financiers and so they are using monetary policy to make it easier for European debtors to pay their Swiss creditors. The secondary factor is to help support the Swiss exporting industry.
The SNB dumps francs and buys euros right on the open market and that's why those 150-point spikes occur on pairs like the EUR/CHF and USD/CHF. I do not trade either of those pairs but if I did I would be watching the SNB and BIS like a hawk and I'd never attempt to trade against them. Traders who are purely technical and who do not pay attention to the central banks have been steamrolled by these interventions and those traders who understand how the central banks affect the Forex market have been on the right side of these moves.
I personally think the interventions can continue in the near-term until the SNB has achieved its objectives. As long as Eastern Europe remains on the brink, the Swiss will likely see to it the CHF remains depreciated against the EUR. Do not fight the SNB on this stuff, it's not worth it. Central banks love using the element of surprise to hit the markets when they least expect it and this week could easily present more opportunities to see a repeat performance.
Correlated markets:Beside all the monetary policy, fundamental and calendar events that will be moving the markets we need to keep up with the price action of crude oil, gold, the S&P 500, Dow, and Treasuries. If the higher-risk, higher-yielding correlated markets make upside moves the dollar and USD Index will come under renewed selling pressure this week. Beside all the underlying fundamental factors, crude and gold will be the two linchpins which can make or break the markets and I will be watching both closely and using both as trade indicators.
Support and resistance levels--In preparing for the trade week I spent some time studying the most recent price action and price behavior patterns of the markets and these are some of the overall key price levels on the upside and downside I'll be monitoring...
Spot crude -- the market has shown a pattern of buying crude when it dips below both the $69 and $67 levels. Below there is more support sitting around the $65 level. I'm not expecting any big downside moves with crude this week unless there are heavy rounds of profit-taking or geo-political factors that might come into play. On the upside strong resistance is seen just above the $73 level with minor resistance seen around the $72/$71 level.
Spot gold -- gold spent most of the month of June in a downward directional move but the same exact day the six ECB's came out to talk the euro up against the dollar, spot gold hit a bottom and has since moved up decisively (not a coincidence). Currently there is some resistance between the $943 and $945 levels while support is sitting at the $923 and $913 levels. Strong resistance for spot gold sits around $988 while strong support is currently around $888. A strong move up in gold this week should carry the euro and pound sterling up with it.
S&P 500 futures -- this correlated market has had a wild ride in recent weeks... the S&P 500 futures made three solid attempts to sustain a break of the 952 level on the topside and failed. On the downside, the market made several runs at the 888 level but also failed to break below there. Near-term support is sitting around 901-900 while near-term resistance is around the 920-925 levels. If the S&P 500 puts in a strong showing it should carry the higher-yielding currencies right along with it or vice versa.
EUR/USD -- price action patterns show the first line of support is strong at the 1.3982 level and then at the 1.3828 level, and then further strong support sits at the 1.3753 level. On the upside, there will be some resistance around 1.4088, then at 1.4178, and then at the 1.4226 and 1.4340 levels. Any of these upside/downside levels can easily be broken this week and the probability remains high for a EUR/USD range break in the days ahead, especially with all the fundamental, monetary policy, and geo-political events going down.
That should about cover things for the week ahead. Like I said at the start, good risk management should be at the forefront of your trading decisions at least over the next 48-hours and especially on Thursday. If you find yourself on the wrong side of the market it's always easier to recover from a small loss than it is to make up when you let a position run away from you.
Finally one last quote from Jesse Livermore:
"All through time, people have basically acted the same way in the market as a result of greed, fear, ignorance, and hope. This is why the numerical formations and patterns recur on a constant basis."
