Yet another wild day in the markets… between GDP, FOMC, various central bank rhetoric, Wall St.’s rally, Treasuries getting hammered, the swine flu alert being raised, and Chrysler teetering on bankruptcy, all markets saw strong price action volatility across the board.
How abysmal headline growth data sparks a rally:
I was shocked to see it but I think we actually got some truth this morning with the latest GDP data. The headline number showed contraction of 6.1% in Q1 while Q4 was revised even lower to show contraction of 6.3%. Yes, those numbers are ugly and I’m sure quite a few market participants were expecting the S&P 500 and Dow to get hammered on this data, but that was certainly not the case. About the only thing that got hammered was the USD Index and Treasuries.
The headline numbers really didn’t matter, especially to those that move markets. It was the underlying fundamentals contained within the GDP report that sent money-flows into risk markets like equities, crude, gold, and non-risk averse currencies such as the euro, pound sterling, and Aussie, and out of the dollar, yen, and US Treasuries. When it comes to using the fundamentals to gauge market direction, sentiment, and where money-flows will go, the thing I do is breakdown the entire GDP report to get a full and well rounded view for how markets should react.
So, what I’m going to do here is go through what I saw in the GDP fundamentals that explain why the markets reacted the way they did; this is the exercise I go through in my mind whenever we get a major piece of fundamental data that will cause strong price action volatility. And GDP is certainly one of those fundamentals that impact money-flows and sentiment.
Prices and inflation–
As we’ve talked about several times the past few weeks in the updates, prices and price inflation are a major catalyst that either drive markets up or drive them down, it’s a very simple correlation. Here’s what today’s GDP data revealed about 2008 Q4 and 2009 Q1 prices/inflation:
GDP price index for domestic purchasing:
-3.9% in Q4 2008
-1.0% in Q1 2009
GDP price index for domestic purchasing ex food and energy:
+1.2% in Q4 2008
+1.4% in Q1 2009
Those numbers are pretty cut and dry. The plunge in consumer price inflation that hammered equities in Q4 of 2008 is subsiding and this is the kind of fundamental data that leads to higher prices of equities and money-flows that go out of the USD, JPY, and Treasuries and back into those higher risk markets. These price and inflation numbers are what I consider to be some of the core underlying fundamentals of what moves markets and money-flows and it’s glaringly obvious why equities have recovered in 2009. The correlation between prices, inflation, and equities shows part of the story for why and how equities have been able to recover, these fundamental correlations are working just as they should should be and even though there are signs of disinflation within other fundamental data, this GDP report reveals possible resurgence of price pressures.
Consumption expenditures–
Next on my list is to see what consumers are doing with their money… are they behaving like consumers or are they still stuffing cash in their mattresses? Well, lets find out.
Real personal consumption expenditures:
-4.3% in Q4 2008
+2.2% in Q1 2009
Now lets look at the durables goods data. Remember, durable goods are those bigger ticket items like appliances.
Durable goods consumption:
-22.1% in Q4 2008
+9.4% in Q1 2009
Seeing a trend here? It doesn’t even matter if this data is fudged, it’s all we have to work with and it’s telling us the consumer is beginning to recover, the consumer is spending more money and gaining confidence, therefore, prices are going up and when market movers see this kind of data, they pile into non-risk aversion markets and drive those prices up too.
I don’t have the time to break down the entire GDP report, but those are some of the main highlights and the key underlying fundamentals that act as catalysts to drive markets and money-flows. With data like that the S&P 500 and Dow couldn’t do anything but go up. And with the correlation that exists between equities and currencies, pairs like the EUR/USD, GBP/USD, EUR/JPY, GBP/JPY, AUD/USD, and AUD/JPY also couldn’t do anything other than go up.
Will a GDP report like this one keep prices surging perpetually? No of course not, most of the time the bulk of the reaction is just during that trade day, but trying to short against those fundamentals was a losing battle for those who were brave enough to attempt such a move. Where price action trading comes into play is by waiting for those markets to exhaust themselves and then playing the retracement. For the euro, after it took out stops at the 1.3340 level, it finally reached the point of exhaustion which also corresponded to another price action pattern of the euro where it over-exhausts itself after moving 220-points or more in a trade day, and our bottom to top move was from 1.3119 to 1.3342.
For those traders who do use charts and tech indicators, the same principle would apply here… trying to go against strong fundamentals wouldn’t work for most of the day while market participants were acting euphorically based on a few pieces of data that will soon be forgotten by the news traders but as this euphoric response died down and their money-flows could no longer sustain the upside moves, then it becomes time to play the over-exhaustion retracement.
Note: if you’d like to read an old commentary I wrote on 8-Feb 2008 where I talk about that EUR/USD 220-point price action pattern, you can read it here.
Wall St. continues rally, Treasuries get hammered:
In our Sunday update we talked about how Wall St.’s rally would continue this week, helped by Treasuries turning lower as they continue losing their bullish momentum. We saw this all play out beautifully today as the S&P 500 and Dow surged to the topside while the 10-year yield sliced right through the 3.00% level, going as high as 3.10% just after the FOMC statement was released.
Overall the markets continue to show a healthier risk appetite even though a significant amount of risk remains in the global economic system. What else contributes to surging equities, currencies, and falling Treasuries?
Crude–
In addition to sharp negative growth in the US and around the world, today’s Crude Inventories showed yet another build of 4.1 million barrels while distillate fuel inventories increased by 1.4 million barrels. In total, commercial petroleum inventories saw an increase of 5.5 million barrels. In other words, there’s a whole lot working against crude right now yet it remains resilient and as long as crude stays supported and participants buy it on the dips, crude’s support will boost equities along with the EUR/USD and EUR/JPY.
But, Wall St. does have at least one obstacle it will have to contend with…
Chrysler bankruptcy–
About an hour before Wall St. closed a few announcements from Chrysler came out signaling a move closer to the bankruptcy stage and almost instantly as this news hit the wires we saw the S&P 500 and Dow back off from their highs above key resistance levels. Sources close to the deal said they were unsure whether or not the conglomerate of hedge funds who hold 30% of Chrysler’s debt would be willing to go along with the deal. If the hedge funds don’t agree there’s almost a 100% probability Chrysler will be forced to file for Chapter 11 and restructure, regardless of Fiat.
The government already brokered a deal with the UAW, so if Chrysler can ink a deal with Fiat in addition to the hedge funds agreeing to their own deal, the likely scenario would be for Chrysler to restructure outside of bankruptcy with the help of the US government. That’s the deal Wall St. wants. Should everything fall through for Chrysler, a bankruptcy announcement could come at any time tomorrow or Friday at the latest, so keep your eyes and ears out.
FOMC:
Today’s FOMC ended-up being a non-event for the most part. They made no move on rates, they didn’t announce any plans to buy more Treasuries, and just as the great Bob Ross would say, the Fed painted “happy little signs” of economic recovery and an easing of the recession. I really don’t have much else to say about the FOMC statement, you can read it here if you like.
Thursday trading:
Earlier this evening the RBNZ dropped their interest rate by 50bps and the NZD/USD got hit right off the bat, dropping almost 100-points. Don’t forget we also have a BOJ rate event later on this evening or early morning. Be on the lookout for their announcement anytime after 2300 EST.
Euro–
Fundamentally, the big event for the EUR/USD is the latest Eurozone Flash CPI Estimate. I’m not expecting a negative print here but wouldn’t be surprised to see it come in at 0.5% which is a slightly under forecast. I’m not expecting a hotter than forecasted print.
Dollar–
There’s quite a few key USD events on the books tomorrow. For me, I’ll be closely watching Initial Claims, and both sets of consumer and inflation data (Core PCE, ECI). In addition, the markets will also get Personal Spending and Chicago PMI which will be watched by market participants. Overall, I’m not expecting any major downside shocks with this data and any upside surprises should be met cheerfully by Wall St.
EUR/USD & EUR/JPY–
Look for the euro cousins to maintain their tight correlation to the S&P 500, S&P 500 futures, and crude on Thursday. If you are a euro trader, technical, fundamental, or otherwise, it’s imperative you keep alert to any rhetoric coming out of the ECB tomorrow and Friday. On Monday the ECB were out talking the euro down, yesterday they were out talking the euro up and the last we heard from the ECB, they were still talking the euro up.
Here’s what ECB Juergen Stark had to say today:
‘In the heat of the debate it’s important not to lose sight of the limits to monetary policy; other central banks can’t be role models for us because they operate in a different environment; we Europeans should focus on our own economic policy principles, the laissez-faire approach failed’
Well that was pretty much a big slap in the face to Ben Bernanke and his comrades at the Fed and Treasury. It’s obvious Stark doesn’t want the ECB to go down the route of loose monetary policy and forced currency devaluation like the Fed. Next week’s ECB rate event is going to be a lot of fun…
And while we’re on the subject of geo-politics and verbal manipulation from central bankers… the past two weeks or so I’ve been getting a lot of email about EA’s, trading robots, and specifically this thing called Fab turbo or something like that. So, I have a question for those who do use trading robots, how do trading robots account for situations like we’ve had this week where the EUR/USD moves 100+ pips based on rhetoric from a central banker?
Specifically, I’d like to know how an unmanned trading robot knows or can comprehend that a geo-political event or rhetoric from the ECB or Fed is what’s causing volatility and price action? If somebody wouldn’t mind taking the time to explain to me how a trading robot or EA makes provision for when a central banker uses verbal manipulation, I’d really be curious to understand it. All I’ll say on that matter is, if any traders do entrust their risk capital to one of these robots, it might be a good idea to get that question answered for yourself, I’m not always going to be around in the chat to alert everyone when somebody from the Fed or ECB uses rhetoric to push the euro or dollar around.
Sticking to the theme… be smart and disciplined with your risk and money management tomorrow. With all the data, geo-politics, possible bankruptcy announcement from Chrysler, and the ECB on the verbal manipulation warpath, those sharp price swings can come at any moment. As bearish as I remain on the euro, I’m even more bearish on the dollar while equities and crude stay supported and continue being bought on the dips.
Key levels will be posted in the morning.
-David
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