First, please accept my apologies to all who’ve inquired about my absence in recent weeks. Life intervened. A parting of ways with a recent employer has meant I’ve taken some short term but demanding projects.

So here’s at least a return to our weekly USD outlook.

The short version: The rally looks durable over the coming months because its drivers appear durable over that period. Here’s a quick review of them. By implication, any weakening of them would weaken the rally.

USD Rally Has Durable Drivers – Markets Tingling With Anticip…..ation (Of Tightening) Vs. Other Currencies

Quick: who can name the cult classic film alluded to in that heading?

For reasons I discuss in detail in my award-winning book, The Sensible Guide To Forex (see here for details, including a free chance to peruse it via the “Look Inside” feature), in recent years the USD has performed as a safe haven asset, so it usually moved in the opposite direction of stocks and other risk assets.

However in recent months the USD has begun to track stocks, which is very bullish as long as stocks continue to trend higher (though the forces driving it could keep it moving up over the long term even if stocks move lower).

That trend got further confirmation this week, as the USD continued its multi week and multi-month rallies vs. most other major currencies, even as stocks broke past 5-10 year old resistance on a number of key global indexes.

If this continues it is a potentially profound change that will radiate through virtually all global asset markets.

Why Does The USD Rally Look Durable?

The reason the rally looks durable over the coming months is that its prime drivers should remain in place. These include:

Fed Hawkish Relative To Other Central Banks

The short, simplified explanation is that unlike those recent years, markets are anticipating that that the Fed is moving in a direction of tightening its monetary while so many other leading central banks (BoJ, ECB, RBA, and probably the BoE, among others) are either holding steady or likely to ease further. After the USD, those banks run the #2, #3, #4 and #5 most widely traded currencies, and their primary counterpart is the USD (currencies always trade in pairs).

As I also discuss in The Sensible Guide To Forex, (p. 183), along with overall market sentiment, the primary near term driver of any currency is the anticipated direction of the benchmark interest rate. Tightening relative to other currencies, should boost the USD, especially because it raises expectations about an increase in the benchmark Federal funds rate.

The recent news stories from Monday and last Thursday about the Fed reducing QE have strengthened the impression the Fed is becoming one of the more hawkish central banks, despite its maintaining historically low rates and loose monetary policy. In forex, all is relative.

Until expectations about Fed tightening are diminished, expect the USD to continue trending higher.

Enduring EU Economic Weakness Brings Euro Weakness Which Brings USD Strength

As we’ve repeatedly noted in past articles, and have explained at length in The Sensible Guide To Forex, EUR weakness forces the USD higher. As we’ve seen repeatedly in the past years, enough weakness in one of these can be enough to drive the other higher regardless of its own merits. Wednesday provided a textbook example of this phenomenon, with the EURUSD hitting a one month low despite weak US data.

Why? Data out of the EU shows that except for Germany, it remains mired in recession. Traders have sold off the EUR due to this continued weakness, which suggests that the ECB will eventually have to find further ways to ease, which in turn would risk further debasing the EUR. Meanwhile the US economy remains overall in slow recovery that should keep Fed policy steady.

Anticipation of further ECB easing got some fuel from the EU’s Industry Commissioner on Thursday when he complained that the EUR was still too strong and called on the ECB to weaken it.

Optimism On US Economy

Some would argue that the relative strength of the US economy is also creating USD demand as foreigners buy up US assets. On Friday a Bloomberg poll showed over 66% believed that the US recovery is now “sustainable” for the next two years, due mostly to accelerating growth in energy production and rising home prices.

However this idea is at least partly refuted by the negative TIC Long Term Purchases data we saw Wednesday, which shows more money moving into foreign stocks and bonds than into those of the US. We suspect that most of that is due to the spike in funds flowing into Japanese stocks, ($6.8 bln out of the total $14.1 bln increase in AUM for equity funds for the week ended May 15).

Don’t Forget Momentum

Nothing succeeds like success. In technical analysis, that means strong momentum perpetuates itself until it hits a technical (aka resistance) or fundamental ( some news that changes market perceptions of its future value).

What Could Halt The US Dollar Rally?

Basically, the biggest threats to the current USD rally would be a weakening in one or more of the above.

Note that we have not covered the numerous headwinds to global and corporate earnings growth. However if these scare markets into risk aversion mode, the USD’s reserve status should allow it to assume its traditional safe haven role, allowing it to paradoxically benefit from opposite conditions as well.

Longer Term Drivers

In the longer term, the USD’s uptrend will depend on continued outperformance of the US economy. The main drivers for that would include continued expansion in the US energy and housing sectors, with the usual follow-through effects on other areas of the economy.

Ongoing geopolitical unrest, currently focused in the Middle East, is also likely to be a periodic driver of USD demand, especially if US energy production growth continues as anticipated and attracts and estimated $100 to over $200 billion in capital investment.

US Dollar Based Investors Should Continue Diversifying Out of The USD

Relative strength of the USD should be viewed as an opportunity to continue to diversify your portfolio and passive income stream into better managed currencies or assets linked to them, at relative bargain prices. See here for details on our award winning book on simpler, safer ways to do that.

Similarly, those lacking USD exposure should plan to get some on the periodic dips along the way.

DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER.

Here’s a quick rundown of prior week EURUSD drivers that are likely to continue to drive the pair

ECB Inaction, Fed Stimulus: Bullish for the EURUSD

Despite considerable deterioration in the EU since the ECB’s last meeting, and Draghi’s dour view on the EU’s growth prospects, the ECB is not making any new easing moves for the moment, although the possibility was left open in case of further deterioration. Meanwhile the Fed, and now Japan, are both engaged in huge stimulus operations. They should inflate asset prices, might help their economies, but are likely to gut the value of their respective currencies, the USD and JPY.

This difference in central bank policy alone should provide some support for the EUR over the coming weeks.

Disappointing US Jobs Reports: Bullish For The EURUSD

The Fed is believed to want to see 6 months of job growth over 200k. We got that last month. If this month’s NFP report had showed about 200k, as was expected, we’d have been a third of the way there and that alone would have added fuel to the USD rally and knocked the EURUSD back further.

However this month’s disappointing 88k new jobs sets the counter back to zero and reaffirms the fed’s doubts about the pace and strength of the US recovery, and thus of the dovish policies currently in place.

EU Complacency: Bullish For The EURUSD

Not surprisingly, the EURUSD got its biggest bounce higher since February.

How much higher is it likely to run?

Much depends on continue complacency about the risk of a new bout of EU banking or sovereign debt crisis anxiety. Still, the events in Italy, Cyprus haven’t spooked markets, nor have rumors of a coming bailout for Slovenia. GIIPS bond yields have stopped rising, and Slovenia seems able to at least defer further bond sales for now, in hope of further calming.

The only other source of new headline anxiety could come from Portugal, where a high court struck down part of the nations’ austerity plan and jeopardizes its bailout package. See here for details.

Look at the EURUSD weekly chart below.

EURUSD WEEKLY CHART JANUARY 2011 – PRESENT

Source: MetaQuotes Software Corp, thesensibleguidetoforex.com

01 apr 07 12 48

The pair looks set to attempt a run back up into the next near term resistance around 1.3150 area in the near term, which is defined by the 4 phased resistance of:

• The 50 week (red) EMA
• The 20 week (yellow) EMA
• The 10 week (blue) EMA
• The 38.2 fib retracement line (third blue line from the top).

Note also, however, that the pair is in the neutral (middle) area of its double Bollinger bands, which suggests weak momentum and thus no more than subdued moves within its recent trading range.

Likely EURUSD Drivers For This Week

Here’s a quick look at the few scheduled events that could provide some new catalyst this week.

The calendar is relatively quiet, but here’s what there is.

Start of Q1 2013 Earnings Season: Effect Unknown

Earnings have been guiding lower, which should be bearish for risk appetite and hence for the EURUSD. However the usual game is to lowball earnings estimates and so engineer a batch of “positive earnings surprises” (that estimates were lowered a few weeks ago is already forgotten) and so markets and risk appetite could just as well rise and support the pair.

Fed Meeting, Speeches

After last Friday’s weak job reports, no changes to the current easing are expected. If anything, we might get hints that further, minor dovish adjustments are possible

US Retail And Inflation Data: Bullish For The Pair

If these are provide material positive surprises (retail sales higher than expected, inflation lower or steady) that could offset at least some of the pessimism generated from Friday’s jobs reports, and feed risk appetite that would in turn support the pair. If retail sales disappoint, that confirms the jobs figures’ dour outlook and the need for ongoing USD- debasing stimulus – also bullish for the pair.

Further Korean Tensions? Unlikely But Bearish if They Come

Further escalations from North Korea could scare markets and thus pressure the pair.

In sum, we don’t see any dramatic moves coming. The pair likely stays well within its recent range, with odds favoring a continuation in the bounce we saw last week.

The big caveat is if stocks and other risk assets finally decide to correct a bit. That could should pull the pair lower along with other risk assets.

Longer Term Fundamental Outlook: Bearish For The EURUSD

Despite the above, longer term fundamental trends remain bearish for the pair.

The Fed is more likely to tighten over the coming year than to make significant new easing measures, especially if the US economy continues its tepid but still positive growth. Meanwhile the EU’s continued deterioration, and likely need for additional bailouts, makes easing and increased money printing more likely, especially if the German elections in September leave a pro-EUR coalition in place.

As always, we remind readers of the importance of diversifying your assets and income stream by currency exposure, just as you do by asset and sector class.

This week Japan moved from mere verbal intervention to active Yen debasement, along with the US and Swiss.

The UK and EU are also likely to head in the direction of further easing over the coming year.

Of course, for those with deposits in GIIPS -CS banks (GIIPS plus Cyprus and Slovenia), or in any other EU country with a shaky banking system, it would be wise to also diversify your deposit confiscation risk and keep as much as possible in deposits outside of these nations. See here or here for information on the best and most updated guide to safer, simpler ways to get that currency diversification.

DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER.

Review of 6 Coming Week Market Movers From The Prior Week

Here’s a quick listing of fundamental and technical forces that drove market action last week and that we expect to continue to influence markets this week. See Part 1 here for a full discussion of them.

Four Fundamental Market Drivers

1. Recent policy moves by the central banks of the EU and Japan: Ongoing BoJ easing likely to continue boosting stocks, lowering the JPY.
2. Continue Complacency about the EU. Significant deterioration and growing risks of a new crisis continue to not be reflected in current price levels, which suggest growth prospects should be as high or higher, and contagion risks lower, than at any time in the past decade. In fact, reality is far closer to the opposite.
3. Ramifications of last week’s monthly US Jobs reports for this week. Stimulus with no end in sight, with Japan nearly doubling what had been coming thus far just from the US. The rally that began in the summer of 2011 with QE 2 suggests this should be enough to keep risk assets up despite the far more dour fundamentals noted in #2.
4. Bearish Divergence between risk currency pairs and stocks may signal at least a coming pause or correction. We could see a 10% correction on the S&P 500 without sustained damage to the overall uptrend.

Two Technical Market Drivers: Ongoing stalemate between

1. Long established upward momentum
2. Decade-old resistance.

Given that the balance of fundamental drivers behind the rally of the past year has not materially changed, we must conclude that the rally is likely to continue until some change in the balance of underlying fundamentals that have driven this rally. These are:

1. Bearish: weak global growth and corporate earnings. These have historically driven asset prices, however they’ve been temporarily overpowered by…
2. Bullish: ongoing central bank stimulus on an unprecedented scale, and with it financial repression that forces yield seeking investors into riskier assets and to accept greater risk in exchange for lower yields than they would have gotten prior to the advent of this coordinated central bank intervention.

Likely New Market Drivers To Appear This Week

Q1 2013 Earnings

While some announcements will trickle in earlier, the season officially begins with global materials bellwether Alcoa (AA), which announces April 8th. These have been steadily revised lower, so expectations are not high. However the usual game is to lowball estimates so that we get headlines telling of upside surprises. The fact that these came from falling estimates gets forgotten and viola, markets rally. So while the continued decline in earnings is predictable, market reaction to them is not.

Are markets ready to take profits with prices at decade highs, or will the upward momentum keep markets selectively focused on the positive?

US inflation and Retail Sales Data

Friday’s reports on US retail sales could confirm the picture of a weak US recovery that was indicated by the poor jobs number, or refute it.

Fed Meeting, Speeches

After the disappointing jobs report, no one expects the Fed to suggest any coming tightening in the coming week’s FOMC meeting and assorted speeches, so this is probably a non-event.

Other Calendar Events. It’s a relatively light week for scheduled events.

Other than the above, China inflation and trade balance data Tuesday and Wednesday are the only top tier events out of an economy that’s big enough to move markets. There is an Italian 10 year bond auction, but it’s unlikely that the EU let’s this look bad unless they want to send a message to Italy about the consequences of failing to install a government that suits the Germans.

North Korea Or Mid- East Flare UP

Markets continue to remain largely unaffected by North Korea’s bluster, which they’ve seen before. However it’s worse than usual and remains the most likely source of a surprise military threat that could scare markets.

Don’t forget the Mid-East. While we don’t expect any action between Israel and Iran, both Syria and Egypt remain on without functioning central government.

Technical Picture: Rising Risk of Further Pullback

Last week was the worst pullback for global stocks this year. A selloff of some kind wouldn’t surprise anyone, and indeed would be considered a normal, healthy development to flush out week hands. Barring any huge surprise from the EU or Korea, any pullback is likely to remain limited.

Conclusion

Until we have some major new catalyst for a bullish or bearish move, the likelihood is for minor, range bound trade.

Sorry if that’s a bit dull, but that’s the reality we face barring a black swan event in Korea or the perhaps the middle east

DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER.

Here’s a rundown of fundamental and technical forces that moved markets last week and which are likely to continue exerting influence this week

FUNDAMENTALS

Here’s a rundown o f the main fundamental market drivers from last week that should continue to exert influence into this week and beyond.

1. – 2. Central Banks

On Thursday the BoJ boosted markets and the ECB knocked them down. We expect to see the impact of these central bank moves continue to influence markets this week.

1. BOJ Feeds Short Yen, Long Japanese Stock Trade

Last week the BoJ met expectations for a bold new easing plan, about 75% the size of the Fed’s, for an economy only about one-third the size of the US. Japanese and related Asian equity and other risk asset markets loved it because:

• They anticipate a boost to risk asset prices similar to that seen in the US from the Fed’s stimulus programs.
• The asset purchases at the heart of the new program are done with new printed money, and that should devalue the JPY. Unlike the US, Japan is an export-oriented economy, so there should be at least some short term jump in exports.
• Markets are simply ignoring the potentially huge long term risks Japan is taking. Everyone knows what they are, but for now investors are happy to take the short term trade and not worry about the future.

As we’ve noted repeatedly in past posts, Japan cannot remain solvent without continued low borrowing costs, yet the massive new easing threatens to send those costs to levels that could bankrupt Japan.

Its benchmark 10 year JGB bond yields about 1%, about half that of the US. Yet even with that low borrowing cost debt service on these bonds is well over 25% of its national budget.

In the past Japan could count on continued high demand, and thus low borrowing costs, from its huge pool of domestic savers. However Japan has the oldest population in the developed world, with over 25% of its people 65 or older, so that pool is rapidly shrinking as it buys fewer bonds and sell more to fund retirements.

Japan is openly attempting to devalue its Yen, so it’s just a matter of time before bond yields start rising as buyers demand higher yield to compensate for the risk of being repaid in much less valuable future yen. Unlike the GIIPS, there is no immediate solvency issue because Japan can print all the Yen it needs to repay those bonds.

However the big risk is that at some point market confidence in the Yen falls enough to put Japan in a death spiral, in which ever rising yields cause more Yen printing, which in turn causes further yield hikes.

The only question is when confidence in the JPY breaks down and bond buyers (especially the growing proportion of foreign buyers for whom Japanese yields are low) will start refusing to buy JGBs, send JGB prices down and yields up, and so start that death spiral.

Many prominent traders and writers, like George Soros, Kyle Bass, Jeff Gundlach, and John Mauldin have all noted these risks, with Mauldin going so far as to call Japan “ a bug in search of a windshield” (Endgame, Mauldin & Tepper, p. 247). Of course timing that breakdown in confidence is nearly impossible, so all we can do is be watchful of it.

For now no one is worried. Of course, just 3 weeks ago Cyprus banks were considered good places to keep money. Just 3 years ago Greek and EU leaders strenuously denied Greece had any solvency problems or that the EU would ever consider bailouts that debase the EUR.

This brings us to another big market mover of the week, though you wouldn’t know it from the headlines.

2. ECB: No Changes Coming Despite Deterioration

Despite continued unraveling in the EU (see the following section for details) the ECB gave no indication of further easing, and that pressured markets for the rest of the day, especially in Europe.  Draghi’s failure to voice much objection to the damage done to depositor confidence from the Cyprus (beyond what we mentioned in Part 1) didn’t help matters.

With potential trouble coming from multiple spots in the EU (as covered below), it’s surprising that Draghi didn’t offer some minor attempt to sooth markets, like reminding them that the ECB stood ready to do …blablabla. We suspect he refrained from such remarks because:

Germany doesn’t want any more EUR devaluing moves until after its elections, so that Merkel can claim she’s protecting German interests and the value of the EUR as much as can be expected.

Markets remained calm about the EU despite the recent weeks’ events. Let’s look further at that topic.

3. EU Crisis Calm: The Thing That Didn’t Happen Kept The Selloff Small

Barring some significant negative surprise, EU calm (complacency, really) looks set to prevail despite every reason that it shouldn’t.

Sometimes a big market mover is something that could have happened but didn’t.

Although European and US markets sold off this week, that pullback could have been much worse if the prior weeks’ nervousness about the EU had continued. Instead, markets largely stayed calm about the EU.

Indeed, the most important gauge of EU confidence, sovereign bond sales, shows all to be calm for now. Both France and Spain had successful 10 year bond auctions that showed yields and demand improving. Granted, major EU stock indexes have been falling in recent weeks (while US and Japanese indexes have continue higher or held steady), but the retreat has been slow and mild, nothing to suggest it’s anything other than a normal correction to be expected after a long rally.

However EU anxiety and bond yields could easily be soaring, and sending markets plunging has they have in the past. Consider:

Cyprus: The rescue program just killed off the nations’ primary industry, insuring that it too is heading for a Greek-like death spiral. Worse, we’ve seen nothing to suggest that the robbery of depositors won’t be used again, and there were multiple articles on that topic, for example, see here. meaning we’ve got heightened risks of bank runs for the rest of the GIIPS, particularly if there are new signs of trouble. Expect those, given that:

1. The past weeks’ data has shown mostly further contraction everywhere in the EU except for Germany.
2. The two biggest contagion risks, Spain and Italy, suffer from both depressed economies that are continuing to contract, and weak or non-existent leadership, so there is little chance of bold new policies to improve things.
3. Germany has a national election in September that greatly limits PM Merkel’s ability to help the periphery, and forces her to show firmness that raises contagion risks in any new EU crisis outbreaks that are brewing, such as:
4. Italy: It’s dependent on its banks’ purchases of Italian bonds, but CDS spreads on those banks’ bonds are rising. See here for details.
5. Portugal: Per a recent WSJ report, a Portuguese high court struck down austerity measures,  creating a gap of €860M in the country’s budget and jeopardizing Portugal’s international bailout package
6. Slovenia: Remains at risk of being the next in line for the EU’s new German-election inspired tough love bailout. Its bond yields remain elevated and it has delayed schedule bond offerings, but can only hold out for a while

Why The Complacency?

That is indeed the question. A few obvious answers:

More immediate concerns from a packed economic calendar: In particular, the big BoJ meeting and US jobs reports and the related preliminary reports scattered earlier in the week.

Crisis Fatigue or Complacency: The last time the EU went after private investors was in the summer of 2011 when the EU was arranging another Greek bank bailout. That in turn caused Italian and Spanish bond yields to spike on fears that those bondholders would face similar abuse and brought a whole new bout of EU crisis that wasn’t ended until new ECB programs to provide liquidity to these banks calmed markets.

Here again a potentially wider and thus more important group of private investors, depositors, was put at risk, yet markets have thus far shown little reaction. It’s unclear if this reflects crisis fatigue or sheer complacency borne of remaining confidence that a solution will be found to protect depositors in bigger nations that present too much systemic risk. Many believe that depositors at TBTF banks in TBTF nations needn’t fear, as we discussed last week here.

4. US Jobs Reports Ramifications  For This Week And Beyond

There was lots written on the meaning of last week’s miserable jobs reports. Here are the real key lessons.

No End To QE 3 In Sight-Great News For Most Risk Assets

We don’t expect the bad US jobs data to have much lasting impact, despite the Friday selloff.

Indeed, we expect to see a “bad news is good” reaction from the markets and media, because the bad news on US employment confirms the Fed’s pessimism on the US recovery and thus keeps in place the current stimulus that has thus far kept risk asset prices inflated and kept rates so low that money continues flowing. That yield seeking cash is propping up not only stocks, but also some of the most battered US housing markets like parts of Arizona, California, Florida and other ‘sand states’ that were presumed to be so overbuilt that prices would remain depressed for years to come.

Overall, in the short term this is more positive than negative for risk assets like stocks. It’s unclear how much job growth could take the place of the Fed’s stimulus as a support for asset prices. Now markets don’t have to guess. Stimulus remains in place, now to be augmented by Japan’s new program that represents a near doubling of cash flowing into global markets.

Japan is just getting started and has no time limit. The US easing still has no end in sight. The Fed wants to see about 6 months of 200K+ job growth. We had that in the prior report, but now, instead of having 2 of those 6 months behind us,  the counter goes back to zero/

Yes, both the USD and JPY are at growing debasement risk. However as long as the global economy remains weak, that longer term problem is a lesser of evils compared to the risk of near term recession or depression. Certainly Europe’s performance over the past year does not support those advocating a more restrained central bank policy like that of the ECB.

Not Good For Savers, Pension Funds, Others Seeking Low Risk Yield

The downside is that the USD and JPY continue to be at growing risk of devaluation due to policies currently in place. The EUR and GBP are at growing risk of similar debasement, as well as currencies of Japan’s competitors for export market share (including perhaps even Germany?).  This again highlights the need for those based in these at risk currencies to diversify their assets and income stream away from these at risk currencies. Those seeking simpler, safer ways to do that than generally found in guides to currency trading or foreign investing should skim through my book via the “Look Inside” feature on its amazon.com page, which can be accessed here (for non-US residents click on the amazon link) or here (US residents), depending on where one lives.

US Job Recovery Remains Weak – Payroll Tax Effect Hitting

Even the booming energy sector saw a drop in jobs. The sequester hasn’t hit yet, so many are speculating that the rise in payroll taxes is the cause of the poor reading, as employees now cost more and those that do have jobs now see lower after tax wages.

This Week’s Retail Sales Reports Now More Important

Consumer spending comprises about 70% of US GDP, so the blow of a weaker jobs report will be either exacerbated or softened by this week’s US retail sales report. The past week’s jobs reports are ominous for retail sales. After adding ~ 32k jobs per month over the past 6 months, the sector shed 24k jobs.

5. Currency Market Trend Divergence A Warning For Stocks

By definition, higher yielding risk currencies trend in the same direction as major global stock indexes, especially the biggest of all, the S&P 500.

However, they’ve been doing the opposite, moving down while the S&P 500 (as well as others like the Nikkei) has been rising.  For a variety of reasons, forex markets tend to lead stocks.

For example, note the chart below.

WEEKLY CHARTS (COUNTERCLOCKWISE) AUDUSD, NZDUSD, USD CAD, AND S&P 500, AUGUST 2012 TO PRESENT

Source: MetaQuotes Software Corp, thesensibleguidetoforex.com

01 apr 051510

These top risk currency pairs should show these currencies rising vs. the USD, similar to the rise of the S&P 500 index (lower right). Instead, however:

• The NZD has made only minor gains
• The AUD has trended flat to lower
• The CAD had fallen (i.e. the USDCAD has been rising).

Source: MetaQuotes Software Corp, thesensibleguidetoforex.com

01 apr 051510

When a potentially leading indicator for stocks, like these risk currency pairs, starts to fall, that’s called a bearish divergence. It suggests that stocks will follow these pairs and trade flat or lower.

6. The Great Rotation Real? Funds Flows Into Bonds Not Stocks

Despite historically high bond prices and predictions of a great rotation from bonds into equities, many of the big name bond funds continue to see new inflows of funds. That undercuts the notion that the rally isn’t purely stimulus driven, but rather also fueled by investor cash is making a strong rotation out of bond funds into equities.

7. TECHNICAL MARKET DRIVERS: A Stalemate Between Momentum Vs.  Resistance

For the past month, despite all the drama in the headlines, the technical picture for risk assets continues to show a stalemate between upward (but weakening) momentum and bent (but not broken decade-old resistance. Neither is broken, but both are showing signs of stress from the other.

S&P 500 WEEKLY CHART NOVEMBER 2010 – PRESENT

Source: MetaQuotes Software Corp, thesensibleguidetoforex.com

01 APR 07 0256

Looking at the weekly S&P 500 chart above, our preferred single picture gauge of risk appetite, we see:

1. Upward momentum intact:

The 10 (blue) 20 (yellow) red (50) and 200 (violet) weekly EMAs all continue to trend higher

The index remains firmly in its Double Bollinger band buy zone, suggesting that the upward momentum is strong enough to trust for opening new long term positions. See here for a quick review of how to interpret double Bollinger bands, which are arguably among the most useful technical indicators.

However that momentum shows signs of weakening:

It’s been in a tight trading range for the past 4 weeks

It has fallen out of the double Bollinger band buy zone on the daily chart

2. Resistance Bent But Not Broken

While the old high of 1556 was technically broken, resistance is viewed more as a narrow price range or band, rather than a specific price. The index has yet to make a sustained break past the area around 1556 and hold there.  Thus we can only call the decade old resistance dented, but as yet not broken.

CONCLUSION

The fundamentals over the course of this rally that began in with QE 2 in the late summer of 2011 that support the above chart haven’t really changed.  Actual economic data has been mixed for the global economy, and slowly improving in the US. Neither these nor  corporate earnings have been strong enough to justify this current run at decade old highs. However the assorted central bank stimulus, or promise of it, and the lack of yield elsewhere, has kept most risk assets rising.

This past week Japan, the #3 economy in terms of GDP, just began its own stimulus program that could include a wide variety of Japanese and foreign asset purchases, and which is about 75% the size of the Fed’s program, nearly doubling the combined easing from just the US and Japan.

For now the rally must be judged as merely pausing rather than reversing.

Please proceed to Part 2 for a our preview of new market drivers likely to appear this week

DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER.

It’s a reminder of what were the key market movers last week, and of what’s likely to move markets in the coming week. Use this to either draw your own conclusions about lessons for the coming week, or as a preparation for understanding the companion article on this week’s market movers.

Monday: Disappointing Asian, US Manufacturing data, Profit Taking Ahead Of BOJ Meeting

Most Asian indexes closed modestly lower as a cautious Tankan survey along with a weak Korean export report also pressured Japanese and other Asian stocks and outweighed  good manufacturing data from Korea, China, Taiwan, Vietnam and Indonesia .

Japan was down hard 2.25% on profit taking ahead of the BoJ meeting and rate statement. This is the most anticipated meeting in recent years because it’s the first with the new BoJ Governor in charge, who is expected to announce radical new easing measures. The profit taking is due to fears that his new actions might disappoint markets.

Many Asian markets were closed for the Easter holiday.

Virtually all major European markets were closed for the Easter holiday. Perhaps that was good timing, given that Spiegel online had a long article out that day on how the Cyprus bail-in of depositors could indeed become a model of future bank rescues. That would raise the risk of keeping money in GIIPS-CS (GIIPS plus Cyprus and Slovenia) banks and could spark a capital flight that by itself could cause a new crisis as banks are bled dry.

All US indexes were solidly lower due to poor data, including disappointing US and ISM manufacturing PMI surveys, as well as the poor Japanese and China reports noted above.

Tuesday: Caution On BOJ Easing Hopes Pressure Japan, Europe, US Up For No Obvious Reasons

Asian indexes were again mixed with modest moves up or down. However once again Japan was down hard, this time on a combination of weak US data from the prior day, and PM Abe’s   cautious remarks about how it might take a long time to beat deflation. Those words had the JPY soaring, while Japanese and related stocks fell over 1%.

European indexes were all up between 1-2%, which was quite mysterious given that EU data was poor  (PMIs and unemployment worsening) and there were no obvious headlines other than talk of increased M&A activity, particularly concerning Vodafone. Apparently short term speculation about possible M&A deals can override data that shows ongoing deterioration of European economies including falling EZ, Spain, Italy and German PMI reports, as well as reports that both French  and Cypriot finance ministers could be implicated in financial scandals.

Meanwhile, the major US indexes were all solidly higher (0.5% or more), and both the DJIA and S&P 500 closed at all time highs despite overall tepid second tier data like a modest rise in factory orders and auto sales. Still, Tuesday was another demonstration that the rally has continued resilience as stimulus and its related low yields continue to drive cash into US stocks even at the current decade highs (and history of deep pullbacks that occurred the past two times US stocks attained these lofty heights.

Wednesday: Optimism On BOJ Easing Lifts Japan & Related, Poor US Data Sinks Europe and US

Asian indexes were mixed, but Japan soared about 3% on speculation that the BoJ meeting will announce open ended new easing that pleases markets.

European indexes were mostly lower 0.5% to 1.3% in response to weak US monthly service PMI and jobs data. This early possible indicator of the big monthly US jobs report this Friday sent the USD lower on fears that Friday’s official BLS job reports will be poor. That would hurt the USD at a particularly sensitive time. It’s believed that the Fed will reduce its dollar –devaluing easing if it gets 6 months of 200k or more increases in jobs. Last month’s report was well over 200k. Another month of close to 200k new jobs would make be the second of 6 and could start raising expectations for reductions in QE 3, and that would boost the USD. If jobs growth falls short, that would likely have the opposite effect and send the USD lower.

US indexes were all solidly lower, about 1% overall, on that same bad service sector and jobs data. Rising tensions with North Korea didn’t help.

Thursday: Central Banks Rule The Day

Asian indexes were almost all lower on weak US data Wednesday, particularly South Korea, as threats from the North begin to exert influence on the chance that these might be more than just the usual empty bluster.

BOJ Lifts Nikkei And Related Stocks

The big exception was Japan’s Nikkei, which soared on (what else?) announcement of new stimulus measures from the new BOJ Governor that pleased investors and promised a flood of new cash to boost asset prices. See part 2, our Conclusions and Lessons section of this article, for details.

ECB Depresses European Indexes

Meanwhile European stocks fell hard on dampened hopes for stimulus from the ECB. Many had hoped that the continued economic deterioration and elevated risk of bank runs after the Cyprus mess would cause the ECB to announce new easing or at hint at future easing. It didn’t, hence the selloff in Europe, and, to some extent, in the US too. Worth noting, Draghi said that the original Cyprus plan to hit all depositors was “not smart,” however he didn’t voice any objections to the stealing deposits over the insured 100k euro amount. Again, see part 2, our Conclusions and Lessons section of this article, for more on this just how much the Cyprus bank rescue is a precedent for future ones.

US indexes finished modestly higher despite Europe’s selloff and a disappointing spike in US weekly new jobless claims. That lowered expectations for Friday’s big US monthly jobs reports. Perhaps this news wasn’t so bad for stocks because if US employment growth remains sluggish, then stocks can continue to rise as QE 3 continues indefinitely. So maybe we have a case of bad news being good news.

 Indeed, if markets see continued QE 3 as more beneficial to asset prices than improved employment, improving job figures may cause selloffs, especially if they show only modest improvement that doesn’t suggest enough spending to replace lost QE 3 funds.

Friday: Bullish BoJ Stimulus, Bearish Bird Flu, US Jobs Reports, Korean Bluster, Technical Resistance

Asian indexes were mixed but Japan was again soaring, up over 1.5% on the BOJ’s aggressive new stimulus program. Korea was down hard due to military threats from the North, and Hong Kong was down hard on concerns about the new outbreak of Asian bird flu hurting growth, and also about recent official moves to cool property prices and limit liquidity from the unofficial banking sector.

All European indexes fell hard 1.5-2% on profit taking prompted by growth worries after a week of bad data from the EU and US was capped by a very disappointing US jobs report. The US gained only 88k jobs versus an expected nearly 200k.  Adding to the temptation to take profits was the fact that stocks face strong technical resistance that has sent past rallies in 2000 and 2007 falling back hard to lose about half their value.  Tensions on the Korean Peninsula added to the temptation to take profits.

US indexes also fell hard on the same combination of bearish factors:

1. Overall bad data in Europe and the US, capped by a miserable US jobs report.
2. Intimidating decade old resistance that has only been bent but not broken on the major US indexes
3. Continued belligerence from North Korea

However once again US stocks managed to bounce and recover well off those European-like lows to close with only half the percentage declines seen in Europe. The bright side of the blatantly bad US jobs figure was that it insured QE 3 continues to push cash and yield starved investors into stocks and other risk assets like the suddenly booming US property market. The Fed is believed to want to see 6 months of over 200k new jobs. It got that last month, but this month’s miserable reading resets that counter back to zero and confirms the Fed’s pessimistic view of the weak US recovery and hence its  dovish policy approach.

DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER.

Ten Things All Must Watch

Regardless of your opinion about the EUR, USD, the EURUSD, or other related EUR or USD pairs, there’s little doubt there will be volatility. However the coming week is much more than just a news trader’s week.

1. We have at least two if not four new brewing sources of short and long term EU crisis anxiety.
2. We have the US monthly jobs reports. These are usually market moving, and now they’re coming at a particularly sensitive time.
3. We have four major central bank meetings and rate statements, at least one of which (BOJ) has been anticipated since mid-November and is expected to announce new easing, two of which are heading towards new stimulus at some point and so a surprise cannot be ruled out (ECB and BOE).
4. We have the unofficial start of US Q1, and thus at minimum some speculation and positioning ahead of the official start, Alcoa’s earnings announcement, which is due April 8th.

Here’s an overview of these and other likely EURUSD drivers this week.

FUNDAMENTAL PICTURE

We discuss most of the below market drivers in greater detail here.

EU

Here’s a quick overview of EURUSD market movers for the coming week and beyond from the EU.

1. – 2. French, Italian Bond Auctions Thursday: Unclear Effect On The Pair

Both nations are selling benchmark 10 year notes. EU crisis watchers use bond auctions as gauge of EU crisis anxiety, similar to how the VIX index is used for US stocks.

1. Italy

As we noted in more detail here, the Italian sale could be particularly interesting. Because of Italy’s systemic risk (#8 in the world, #3 in Europe in terms of GDP ahead of India, Russia, Canada, Australia, among others), the EU does all it can to insure a decent looking auction. However Italy has been showing some attitude to the EU as of late, and so may need some reminding to behave itself. Spiking bond yields were what drove the last PM from office, so bond markets could again be used against Italy.  A poor auction would spike EU concern and hurt the EUR and thus the EURUSD (currencies move up or down with the base currency, the one on the left).

2. France

France has been like the US of Europe in the sense that its data hasn’t been great but it still looks good relative to the rest, so its bond yields have remained low despite ongoing economic contraction and banking system that deeply exposed to the GIIPS. France has a GDP of about $2.5 trln. For example, French banks have about $400 bln of Italian debt alone, about 16% of French GDP, and about $144 bln of Spanish debt, about another 5.7% of French GDP.

3. – 4. Growing Contagion Fears: Bearish Longer Term, Short Term Unclear For the EURUSD

• Cyprus: The current regime of capital controls is officially slated to last seven days; however they’re widely expected to remain in place for at least the coming months. The longer they stand, the deeper the damage to confidence in the safety of GIIPS-C (GIIPS plus Cyprus) (or GIIPS-CS if we include Slovenia) deposits. The EU claims the Cyprus deal was unique, but as FT’s Wolfgang Munchau correctly points out here, that’s true only in a narrow legal sense. The second Greek bailout’s ~90% haircuts to Greek bondholders in the spring of 2012 already set the precedent for private sector “participation” (and also set in motion the Italian crisis of that summer on contagion fears,  and the current Cyprus crisis due to Cyprus bank exposure to those same bonds – real contagion – but never mind).

• Slovenia: As mentioned in our post here, Slovenia is the next big expected crisis hot spot. Its bond yields are up about 40% in the past two weeks due to all of the unpleasant similarities between it and Cyprus. As noted below, given the political needs of German leaders, this isn’t a good time to be seeking EU aid.

5. Italian Politics: Bearish For the Pair

After last week’s failed attempt at forming a coalition in Italy, the President is expected to appoint a caretaker government that will likely end in new elections in the coming months, keeping political uncertainty hanging over Italy.

6. German Politics: Bearish For The EURUSD

Germany’s September elections mean its leaders must show added firmness in future EU bailouts. Ask the Cypriots about that.

7. EU Data: Neutral/Bearish

A batch of EU PMI sentiment surveys provide the latest look at the ongoing contraction throughout almost the entire EU except for Germany. Expectations are low, but can even those be met?

There are also inflation reports for Germany and the EU. Inflation is expected to remain quiet, and it needs to stay that way in order to allow the possibility of more stimulus if needed. If inflation does pick up, Germany and other hard money funding nations will be even less likely to support new easing until after German elections this September.

8. ECB Meeting: Neutral/ Bullish

No changes expected at this time, but things have gotten worse since last month’s meeting, so we wouldn’t be surprised to hear Draghi sound more pessimistic and offer at least some reminder of future easing.

US

9. Monthly Jobs (And Related) Reports: Neutral/Bearish For The Pair

Unless the US monthly job figures badly disappoint markets, the employment situation still looks almost utopian compared to that of the EU, especially if you pull out Germany. As we discuss more here, if we get a second straight month of over 200k new jobs, that alone could start markets speculating about an earlier than expected reduction of QE 3, and would be very bullish for the USD, and hence very bearish for the EURUSD.

10. TECHNICAL PICTURE: Short Term Unclear, Longer Term Bearish

Given the sharp downward momentum, and amount of bad news already out, you can argue for a short term bounce in the pair. Sentiment also looks oversold, but of course that can continue and isn’t of much predictive value.

Unlike the S&P 500, however, the EURUSD’s momentum has all the fundamental support you could want, so we’re confident in that the second leg of the EUR’s secular bear is still intact. We’d hesitate to put in new shorts, however, until we get a bounce back into the 1.3150 area, where we’ve resistance from:

• The 38.2% Fib retracement level
• The 50 (red), 20 (yellow) and 10 (blue) week EMAs

WEEKLY EURUSD CHART MID 2010 – PRESENT

Source: MetaQuotes Software Corp, thesensibleguidetoforex.com

01 mar 31 1512

One Thing’s Clear

The US is actively debasing the USD, Japan is expected to start its own new easing this week, and it’s a matter of time before the ECB and BOE do the same. That’s bad news for anyone whose wealth is tied to these currencies, and makes diversifying your exposure away from them all the more important. That doesn’t have to be any more risky or time consuming than your current preferred mode of investing or trading. See here for the most up to date guide of simpler, safer solutions than you’ll find in other guides to forex or foreign investing.

DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER.

This is the most event packed week thus far in 2013. Here’s a brief rundown of what’s coming.

Fundamental Picture

There are significant top-tier events from all of the top three economic zones this week.

EU

Perhaps the one positive out of the Cyprus mess is that markets now remember that contrary to EU leadership claims, the sovereign debt and banking crisis isn’t any closer to resolution than it was after the ECB’s OMT program was announced in mid 2012.

Complacency about the EU has been a huge plus for risk asset markets, probably the #2 most bullish factor in the global risk asset rally after assorted central bank stimulus programs, actual or verbal. That prop is gone for now.

1. SLOVENIA

Slovenia is the likely spot for a new EU crisis. It is perhaps the biggest sovereign loser out of the whole Cyprus debacle, after Cyprus itself, because it has the most in common with Cyprus, and is likely to need a bailout itself soon.

• Not in a rescue program yet but soon to need one. Events in Cyprus have reminded everyone that it too has an oversized banking sector that’s in trouble. Rising bond yields are the big warning sign of a new EU crisis, and Slovenia’s are up over 40% in the past two weeks thanks to Cyprus.

• Like Cyprus, its request will come at time when conditions make it harder to make a credible contagion threat and thus pressure the EU for concessions, because markets appear to be suffering from a combination of

• Pre German electoral concerns: Most importantly, Europe’s paymasters need to show Germany’s voters that their interests have been well protected. Thus Germany will be sparing with concessions, and force others to bear more of their own burdens than in the past. Indeed, the big winner of the Cyprus affair was likely Angela Merkel.
• Crisis fatigue (they’re less easily spooked by contagion threats, having become used to them and used to last minute deals)
• Unwarranted confidence that the EU leadership knows what it’s doing and has the common good at heart, despite the events of the past week
• It may be too small to present a systemic threat, and so be more vulnerable to a Cyprus-type harsh treatment program. Per assorted GDP rankings Slovenia ranks in the high 70s, right in the middle between of the rankings  between Cyprus’  (around # 100) and Greece (#34 – 40).

2. -3. Italy, Cyprus,

Continued lack of a coalition in Italy and Cyprus’s evolving bank rescue (no EU money actually paid out until an official assessment made) should continue to influence markets, mostly in a bearish manner, the only question is when the next headline hits.

For this week, the more likely Italian market moving event may be Italy’s 10 year bond auction. Given the stakes, the EU tends to do its best to insure all looks ok. However after the failed coalition attempts, it may feel that Italy (or more specifically, its President) needs a reminder to do what’s needed and install a pro-EU (i.e. austerity) caretaker government until either a stable coalition or new elections are chosen. Spiking bond yields were the weapon that pried Berlusconi from office, so bond markets may again be the tool for influencing Italy.

As we noted in our review of last week’s lessons for this week here, the significance of the Cyprus deal is that it casts doubt on the safety and liquidity of all GIIPS bank deposits and hence makes them all more at risk of capital flight. Cyprus’s capital controls are officially in place for just seven days, but they’re likely to be renewed into the foreseeable future. The longer they’re in place, the deeper the damage to confidence in GIIPS banks and the bigger the risk of bank runs that by themselves could spark a new chapter in the EU crisis.

4. – 5. EU Calendar Events: PMIs, Bond Auctions

Purchasing Manager Index surveys will provide the latest update on the EU. These are likely to continue to paint a bearish picture of continued contraction for the EU outside of Germany.

Italian and French auctions of benchmark 10 year notes will also provide potentially market moving news from the EU. Italy suffers from deep recession and a lack of a stable coalition to deal with that, so it’s vulnerable to a spike in borrowing costs.

6. ECB

The ECB’s monthly meeting and rate statement are not expected to yield any changes, but any hints at coming easing measures would help boost risk assets and further pressure the EUR. Given the deterioration since the last meeting, most notably events in Cyprus and Italy, as well as spiking bond Slovenian bond rates, a surprise attempt to ease cannot be ruled out.

7. – 8. Other Central Bank Meetings

The big one this week is made in Japan. The Bank of Japan (BOJ) rarely provides much market moving news, but this time it is likely to move both Japanese and related Asian stocks, as wells as the USDJPY and other Yen pairs. That’s because these have been moving (stocks rising, Yen falling) for months now on little else but anticipation of new BoJ easing. The Yen is down nearly 14%, and Japanese stocks are up nearly 20%, since new elections were called in mid-November. That started the speculation about a more pro-easing government and BoJ head. Although new easing steps are expected at this meeting on Thursday, it’s hard to believe the BoJ will exceed expectations, so the trends in the Yen and Japanese stocks could well see at least a short term reversal on profit taking from long Japanese stock and short Yen positions.

The central banks of Australia and England also have meetings and rate statements this week. Any surprises would move their own currencies and indexes.

US

Monthly jobs reports, manufacturing and service PMIs, Fed speeches, as well as speculation on quarterly earnings, all combine to make this week particularly significant.

US monthly jobs reports, as well as those that come earlier in the week and offer hints on the outcome (the jobs components of the PMIs, ADP NFP report, for example), are typically among the biggest events of the month. If anything, these NFP and unemployment reports are even more important than usual.

9. Monthly Jobs (And Related) Reports: The Big QE 3 Indicator

US monthly jobs reports, as well as those that come earlier in the week and offer hints on the outcome (the jobs components of the PMIs, ADP NFP report, for example), are typically among the biggest events of the month. If anything, these NFP and unemployment reports are even more important than usual.

Last week Chicago Federal Reserve Bank Charles Evans noted that he wanted to see 6 consecutive month of over 200k job growth before he’d support any reduction of QE 3. Bernanke probably feels the same way.

QE 3 is the primary driver of the US stock rally in the face of data and earnings that don’t support the current historical high or high levels in stocks, US farmland, and other risk assets.

US jobs reports (ok, retail sales and GDP also important) are the biggest single driver of the decision for when to pare back QE 3, and probably these same asset prices.

The last three months showed 155k, 157k, and most recently 236k for February.

Markets are forward looking, so it will be interesting to see how many months in advance risk asset markets will start pricing in QE 3 withdrawal, and whether it makes investors feel optimistic enough to continue the rally or if it causes a selloff.

Thus far the consensus estimate for Friday’s NFP is just around 200k. A second straight 200k month makes it two out of six.

However it’s not clear how that news would be interpreted. Remember, markets have been moving higher on little besides speculation for continued stimulus for the foreseeable future. A strong report that suggests an early end to that easing could thus be taken as more negative than positive

10. Earnings Season Speculation

Q1 2013 earnings season kicks off with global materials bellwether Alcoa (AA) earnings announcement April 8th, but speculation about it, as well as US earnings in general, could hit even this week. Expectations are not high given the steady stream of downward revisions, so it’s unlikely we get any bearish surprises. Typically, the idea is to low ball expectations in order to allow more companies to beat expectations, which many forget were just recently lowered.

11. China Manufacturing PMIs

Chinese manufacturing PMIs, both the official and HSBC versions, come out Monday and are the only potentially market moving events until the US manufacturing PMI comes out later in the day.

12. Technical Picture: Bullish Momentum Vs. Bearish Resistance At Decade Highs

As in prior weeks, the weekly chart for the bellwether S&P 500 shows nothing but upward momentum.

• Weekly EMAs from 1- to 200 weeks all moving up
• Price firmly in the upper, double Bollinger band buy zone. See here for a quick summary of the rules for interpreting these.

Yes, we’re at decade highs, but we’ve been near them for weeks, so this too isn’t new. In sum, we still have a case of bullish momentum vs. bearish decade-old resistance. Thus far stimulus-fueled momentum and relative outperformance of the US economy has kept US risk assets and, contrary to normal correlations of the past years, the USD, rising higher.

S&P 500 Weekly Chart January 2011 – Present

Source: MetaQuotes Software Corp, thesensibleguidetoforex.com

01 mar31 0515

One True Thing

All of the above event risk brings uncertainty. However one thing is clear.

While the BOJ has talked about easing, so far it’s been nothing but talk. Japan’s central bank is expected to announce actual easing at this week’s meeting. The Fed is already committed to pumping $85 bln per month into the markets. It’s just a matter of time before the ECB and BOE need to start new easing steps to prop up their weakening economies. That may be good for their growth, but it’s likely to drag down their currencies and anything attached to them.

See here for the most up to date guide of simpler, safer solutions than you’ll find in other guides to forex or foreign investing.

DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER.

Here’s what we learned from the prior week’s market activity. The idea is to provide a quick summary of the top market drivers each day on all three continents, and then derive whatever useful conclusions we can for the coming week and beyond. I do this because I need it and no one else does it.

First, here’s a quick wrap up of what happened and what caused it each day in all three regions.

Monday: Early Rally On Cyprus Deal Reversed By Dijesselbloem Remarks

Asian indexes closed mixed mostly higher, Japan (1.69) and Honk Kong (0.61) strongly higher on news of a deal between Cyprus and the EU. The key point was that the deal left insured deposits untouched, and thus dodged the dangerous precedent of violating the protection of EU deposit insurance. That risked undermining confidence in the safety of EU bank deposits, particularly in GIIPS nations, and encouraging bank runs that could start a new and potentially fatal chapter in the EU crisis.

While much detail was missing, it was clear that deposits of over the 100,000 euro limit of EU deposit insurance at the two largest banks would bear the full burden, and that there would be at least some temporary capital controls. Those controls had some correctly realizing that Cyprus while these remained in effect Cyprus was in reality out of the Euro-zone because a Euro in a Cyprus bank wasn’t as liquid, and thus worth as much, as a Euro elsewhere in the EZ.

EU solidly lower about 0.6% typically after a strong early rally that fell apart as euphoria about the new EU-Cyprus bank bailout deal collapsed. The cause of that breakdown was Euro group’s Jeroen Dijsselbloem’s excessively honest comments that the bailout deal would be a template for Euro zone bank rescues. These words re-ignited fears about the safety and liquidity of bank deposits, and thus of bank runs, in the EU, especially in the EU’s soft spot – GIIPS nations’ banks. It was bad enough if he was referring to “bail-ins” by uninsured depositors, but even worse if he was referring to capital controls and border checks.

He and the rest of EU officialdom quickly began backtracking on that statement. European indexes would spend the rest of the week trying (unsuccessfully) to recover from concerns about EU bank deposit safety. See the Conclusions and Lessons section below for more on that.

As the week progressed, it became clear that capital controls were indeed part of the deal. How long they’ll be in place is unknown, probably for as long as Cyprus sees a threat of bank runs. That could be a long time, because it’s hard to see why any foreign depositor would want to keep funds in Cyprus anymore.

US indexes closed moderately lower, about 0.35%, and in fact recovered from deeper losses after Dijsselbloem attempted to revise his earlier statement on how the Cyprus bailout was a template for future EU bank failure resolutions. Also helping US stocks was NY Fed’s Dudley saying the US must continue with stimulus because of the weak jobs market.

Tuesday: Markets Rise By Focusing On Good US Data, Ignoring The Bad, Stimulus Hopes Support Japan

Asian indexes closed mixed mostly lower on continued worry that the Cyprus deal could yet cause contagion because of its precedent setting losses to uninsured depositors and capital controls. Losses were capped in Japan and those related to it by (what else?) hope for more stimulus being announced at next week’s BOJ meeting. New Governor Haruhiko Kuroda reiterated the BOJ’s determination to expand its balance sheet more aggressively in order to stop deflation, and push down bond yields of all maturities via purchasing longer dated (as well as the more customary short term) Japanese government bonds.

European indexes were mostly solidly higher, over 0.5%, as investors focused on better than expected US durable goods and house price data, and ignored much worse than expected consumer confidence and manufacturing data, and also shrugged off the worries about Cyprus-inspired GIIPS banks runs and Italy’s continued inability to form a new ruling coalition.

US indexes were also solidly higher as the DJIA hit a new high and the S&P 500 closed a mere 2 points below its all time high as traders followed Europe’s cue of focusing on the good US data and ignoring both the bad data as well as the mess in Cyprus and Italy.

Wednesday: Asia Up On Follow Through From US, Europe And US Down On Italy, Cyprus, UK Concerns

Asian markets closed higher on good US data for home prices and durable goods.

European indexes were down hard, around 1%, on concerns about unresolved long term political instability in Italy, contagion risks from the evolving Cyprus crisis, and downbeat Bank of England comments on the massive risks to UK banks and thus the need to raise their capital requirements.

The plunge also hit the EURUSD, sending it to fresh monthly lows, breaking near term support and ultimately heading lower to test deeper support

US markets closed mixed with overall only minor pullbacks as an down opening was used as buying opportunity, for all the same reasons that have kept US markets rising towards historic highs despite bad data from most of the developed world, a US economy still nowhere near 2007 levels, and declining earnings (stimulus and…anything else besides hopes for more stimulus?). Optimistic comments from two dovish Fed Presidents also helped. See our Conclusions and Lessons section below for an important lesson from Fed President Evans.

Thursday: Asia Mixed On Follow Through From US, Europe, US Both Up On Smooth Cyprus Bank Opening, Focus On Positives In German Data

Asian indexes were mixed, with Japanese indexes down hard on Italy’s rising borrowing costs and how Cyprus bank re-openings will go. Chinese indexes were down harder on worries over new restrictions on the property sales and China’s infamous wealth management products, which are part of an unregulated and opaque shadow banking industry.

European indexes ended higher due to a smooth bank re-opening in Cyprus, despite mixed data from Germany showing better than expected retail sales but a worse than expected unemployment change.

US indexes closed solidly higher as a combination of momentum and follow through from Europe helped push indexes higher and the S&P 500 to a new all time high of 1568. US economic reports were bad, with both first time jobless claims and Chicago PMI worse than expected.

Who needs fundamentals like economic and earnings growth when you’ve got plenty of stimulus and most other markets look worse?

For the US, Europe, and much of Asia, Thursday was the end of a shortened trading week due to Good Friday.

Friday: Most Markets Closed For Good Friday

With so many markets closed the day had little significance.

Of the Asian indexes that were still open, the Nikkei, Kospi, and Shanghai indexes were all up about 0.5% on combination of Asian fiscal year end window dressing purchasing, upbeat mood after the new S&P 500 all time high of the prior day, capped by some profit taking on caution ahead of a busy week ahead that includes 3 major central bank rate statements and US monthly jobs reports.

European and US stock markets were closed for good Friday. Forex markets were open, but trade was quiet.

See part 2 for conclusions and lessons derived from the above.

DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER.

Following up from part 1, here are the conclusions and lessons gleaned from last week’s market action for the coming week and beyond.

Conclusions And Lessons: Cyprus, Importance Of Coming Week

First, here’s an update on the confiscations of deposits at Cyprus’s biggest bank, the Bank of Cyprus. Early in the week it appeared that deposits over 100k Euros would take a 30% hit. Later in the week we started hearing 40%. As of Saturday, it was reported that the official decree would give depositors shares worth just 37.5% deposits over 100k Euros, assuming those shares can actually be sold at the issue price. So at best those deposits over 100k Euros face a 62.5% hit. It could get worse if the shares lose value or if there are restrictions on selling the shares.

Depositors with sums of over 100k Euros at the second largest Bank, Laiki, have nothing to fear. They’ve already lost everything over the EU insured 100k.

There have been no changes to the controls on cash and credit card withdrawals announced earlier in the week.

Winners And Losers

The Losers

Europe

• Continued Contraction, Bad Data: While German data shows it’s economy is still holding on, the rest of Europe looks awful overall, and the only debate over the GIIPS is whether or not they’re already in a depression on the scale of that seen in the 1930s. See here for a sample of the articles this past week on that theme.

• Italy And Cyprus: The two big EU concerns of recent weeks both appeared to be hitting their worst case scenarios.

Obviously Cyprus was THE big loser. See below for all the gory details.

Italy couldn’t form a government, which means months of lingering political uncertainty and probably new elections within the year to replace the temporary caretaker government appointed by the President.

The big ramification is that the EU could be pressured by heightened political uncertainty for much of the remainder of the year at a time when it desperately needs the opposite in order to maintain confidence in the face of the continued contraction noted above.

Germany also has elections later this year and the existence elections in both the major creditor and debtor nations’ risks pushing both polities to opposite extremes as candidates in both elections play to voter fears about the other nation.

China

Markets were stressed by fears of increased regulations to cool property prices and sales of opaque but profitable “wealth management” investment products.

The Winners

The US, as much by default as anything else, as its indexes continue higher and its economy continues to slowly improve under continued stimulus. The US isn’t as bound to the decaying EU as Germany, it isn’t a demographic disaster like Japan, and it isn’t in a tightening process like China. No wonder money continues to pour into US stocks as investors accept higher P/Es, and the S&P 500 was finally able to break to new highs despite declining earnings growth.

Seven Big Cyprus Ramifications

Oof. Where do we even begin? So much has already been written, not without justification. This was big. For the first time since the Greek bond haircuts (which hit Cyprus banks and arguably were a key driver of the Cyprus mess) real pain was inflicted on investors rather than taxpayers. That brings contagion risks, as we discuss below. Here are the key ramifications thus far.

1. Defined The Template For EU Bank Bailouts: Systemic Risk The Key

Markets freaked on Monday at the suggestion that the Cyprus bailout was indeed a precedent for confiscating deposits and capital controls in future EU bank bailouts. The implication was heighted risk of massive bank run on GIIPS banks and end of the EU.

Of all the articles I read that attempted to define the how the Cyprus deal had increased contagion risk, the Telegraph’s Jeremy Warner hit it best. In essence, he wrote that deposit safety correlated directly with how much of a systemic risk a given bank presented. That risk was defined by both the size of the bank and its sovereign state. He likened the situation to that of the US, where depositors at small local banks lose everything when federal authorities close them down, but those at big banks with huge corporate depositors and international presence (aka TBTF banks) get bailed out because they would take down their big corporate and sovereign depositors with them. See here for details.

2. Cyprus’s Future: Depression, EU Exit

Despite all the pain, it’s very unclear whether Cyprus will avoid the death spiral and probable EZ exit occurring in Greece.

• The deal killed off Cyprus’ main industry and best paying employer, its offshore banking industry.

• The deal still leaves it with over 140% debt/GDP, which most economists do not believe is sustainable under any circumstances. Cyprus’ economy just lost its biggest driver, offshore banking, so chances of recovery are virtually nil.

3. Cyprus Capital Controls Mean De Facto EUR Expulsion

If a Cyprus Euro isn’t as liquid as any other, it isn’t worth as much and thus Cyprus is no longer a full EZ member. No doubt depositors in banks of other at risk nations will take note, and those with over 100k Euros on deposit at any one bank will be far more inclined to take these funds elsewhere while they still can.

Thus far, these include:

• Withdrawal limits of 300 Euros
• Maximum transfers of 5000 Euros
• Restrictions on credit card use
• Limits of 1000 Euros that can be taken abroad

That means….

4. Contagion Risk Up

This is the biggest lesson of the prior week, and its effects could be felt for months or years to come.

The Cyprus deal dispensed with any doubt that EU bank deposits (as well as those in the US and UK) are less safe than previously believed, especially those in the GIIPS nations’ banks. A lot was written about that last week. See here, here for examples of the genre.  Key points include:

• Bank Runs, Long Term Capital Flight More Likely: For bailed out nations, depositor contributions to bailouts and capital controls (which effectively make Euros in these banks less liquid and thus less valuable. In other words, a nation can be stuck with a second class Euro and subject to a light form of EU expulsion. That risk will now weigh on depositors of all GIIPS banks and make them quicker to flee in the future. Why would anyone keep deposits in GIIPS banks unless it was absolutely necessary? Even insured depositors can see their access cut for an indefinite period, as the Cyprus deal demonstrated.

• Future Bailouts Harsher: It’s become politically suicidal for funding nation leaders to bail out debtor nations without squeezing maximum cash out of these countries first.

• Borrowing Costs Up For GIIPS Banks: Unlike Cyprus, the other GIIPS nations have bondholders who can take losses before depositors, so it’s going to be harder for GIIPS banks to get interbank credit needed for daily operations. In other words, these challenged banks now have another challenge to overcome.

To be completely fair, there are those who insist that while EU depositors are now on the bail-in menu, the protection of insured depositors has definitely been confirmed.  We disagree. EU leaders (and initially Cypriot politicians too) were ok with hitting insured depositors. It was popular opposition in Cyprus that prevented this move.

The last time private investors (i.e. the ones that rule the markets) rather the taxpayers had to take this kind of pain was the Greek bond haircut in the summer of 2011, which led to spiking borrowing costs in Spain and Italy.

Risks of new crises in Spain and Italy are trending higher along with their bond yields, and markets are focusing on Slovenia as a likely next hot spot. See our article on the top market drivers for the coming week here for more on that.

5. Continued EU Anxiety Means Continued EUR Downtrend, USD Uptrend In Months Ahead

All of the above serve to remind us all of just how big a mess the EU really is, and that’s brought a new batch of articles predicting the EU’s demise. Here’s the best I saw last week.

European stocks have been flat-to-lower in recent weeks, but the EURUSD and other EUR pairs have been sliding hard since the start of February. Barring assorted short term counter moves, this longer term trend, in place since early 2011, should remain in place, and provide some support for the USD and USD investments.

6. Contagion Risk Beyond The EU?

The Cyprus deal raises questions about deposit safety even outside of the EU, and that produced some interesting commentary last week. Quick, which investment is more senior in the event of a bank failure, a savings account or derivatives counterparties? See here for the answer. This article has held on for 3 days at the very top of seekingalpha.com’s top article list as of this writing. That only happens when an article really hits a nerve.

7. Harsher Bailouts Until After German Elections

German voters have not been kind to the ruling coalition in recent years, and that’s believed to be due to anger at seeing their money loaned or given to GIIPS nations of dubious creditworthiness. Much was written last week about how German PM Merkel was the big winner from the Cyprus deal. As Wolfgang Munchau wrote (via businessinsider.com here)

There are so many reasons why Cyprus was a win for Merkel:

• She got to show her tightfistedness (even though we were never talking about much money).
• She helped insure a diminished future for the Cypriot banking system.
• She stuck it to the Russians.
• She did it all while creating virtually no financial contagion/ripple effects elsewhere in Europe.
• She showed that there’s no serious opposition to Germany among the rest of the nations.

Next Week Is Big

The first week of the month is usually busy, and the above makes it even more important.

EU Data

It’s packed with top tier EU PMI reports, bond auctions of benchmark 10 year bonds, and more. See our article on coming week market movers for more.

Fed President Evans: Watch US Jobs Reports Next Week – Closely

Last week Chicago Federal Reserve Bank Charles Evans noted that he wanted to see 6 consecutive month of over 200k job growth before he’d support any reduction of QE 3. Bernanke probably feels the same way.

QE 3 is the primary driver of the US stock rally in the face of data and earnings that don’t support the current historical high or high levels in stocks, US farmland, and other risk assets.

US jobs reports (ok, retail sales and GDP also important) are the biggest single driver of the decision for when to pare back QE 3, and probably these same asset prices.

The last three months showed 155k, 157k, and most recently 236k for February.

Markets are forward looking, so it will be interesting to see how many months in advance risk asset markets will start pricing in QE 3 withdrawal, and whether it makes investors feel optimistic enough to continue the rally or if it causes a selloff.

Thus far the consensus estimate for Friday’s NFP is just around 200k. A second straight 200k month makes it two out of six.

See our article on the coming week’s top market movers for details.

Finally, we remind everyone (who else will?) that if most of your wealth is tied to the Euro, US dollar, Yen, or other at risk currency, then you need to diversify your holdings and income stream by currency exposure, just as you’d diversify it by asset class and sector. See here for the most up to date guide of simpler, safer solutions than you’ll find in other guides to forex or foreign investing.

DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER.

Here’s a quick review of the week’s likely market movers for the pair. It’s reasonable to expect more of the same tight range bound trade this week in the 1.289 – 1.299 area, given the following:

1. The light calendar
2. End of week Good Friday liquidity drain
3. Continued tight range bound trade and lack of direction on the weekly chart (below)

However there are a number of very potent market movers to watch out for this week. Here’s a quick review of them. For further details see our weekly preview of top market movers for the coming week here.

1. Cyprus Bailout: Anticipation and Reaction To It: Neutral To Positive for the EURUSD

While we should have a picture of the basic terms early in the week, the full picture may take longer to emerge.  Despite the dramatic headlines, market reaction was muted last week, suggesting a blasé attitude after having endured endless last minute deals already. That same attitude is likely to limit the relief rally if a deal is reached, just as much as it contained the pullback in risk appetite last week

See here for further details on how the latest outbreak of “Cyprosis” did and didn’t change the EU situation.

2. Italian Coalition Formation: Bullish for the EURUSD if it looks stable, Bearish if not

Center left leader Bersani will attempt to form a coalition. Failure risks a care-taker technocrat imposed by the President, which likely means another election in the coming months and more uncertainty and lack of leadership that will not inspire market confidence.

3. Italian 10 Year Bond Auction: Bearish if EU uses it as a warning

Bond markets forced out Berlusconi, so it’s possible that they’ll be used again to remind Italian voters to cooperate and support a candidate that can make Brussels smile rather than laugh.

4-9. Calendar Events Worth Watching

It’s a typically light end of month docket this week, but not without a few potentially market moving events for the EURUSD. These include

• Tuesday: US durable goods, CB consumer confidence, new home sales

• Wednesday: US pending home sales, Italy 10 year bond auction (see above for details)

• Thursday: US weekly new jobless claims, Chicago PMI

Note also:

• Good Friday should drain liquidity in Western markets Thursday and Friday, suggesting quiet range bound trading, which is also the likely result per the weekly chart below. However, these low liquidity days are potentially extra volatile if there is any major surprise.

• Some very big EUR depositors in Cyprus banks learned a painful lesson last week about having too much in one currency in one domicile. Those exposed to the other GIIPS nations no doubt are taking note. As in prior weeks,  Japan prepares to devalue the Yen, and the US is actively turning out $85 bln per month in new dollars. See here or here for details on the latest guide to safer, simpler ways to diversify your assets and income stream by currency exposure.

10. Technical Picture: Neutral This Week, Longer Term Remains Bearish

Note the EURUSD weekly chart below.

Source: MetaQuotes Software Corp, thesensibleguidetoforex.com, The Sensible Guide To Forex

01 mar 24 0601

The chart shows a trading range lacking momentum in the near term:

• Price itself has been in a tight range for the past two weeks, and remains within the neutral zone of the double Bollinger bands, suggesting no real direction. See here for how to interpret double Bollinger bands.

• The weekly 20 (yellow) 50 (red) and 200 (violet) EMAs are flat

Longer term the downtrend is in full swing. Nothing in the EU’s fundamentals or recent events contradicts that.

DISCLOSURE /DISCLAIMER: THE ABOVE IS FOR INFORMATIONAL PURPOSES ONLY, RESPONSIBILITY FOR ALL TRADING OR INVESTING DECISIONS LIES SOLELY WITH THE READER.