The return of euphoria:

Good earnings, hot consumer price inflation, and a textbook short-squeeze scenario skyrocketed the S&P 500, Dow, crude oil, and gold while sending the US dollar Index sliding below its support, dropping down to the 79.50 level and closing for a 1% loss.

The good news for equities, commodities and higher-yielding currencies… CPI made its biggest jump in 7-months while the key Core CPI showed a 1.7% gain year-over-year. CPI and Core CPI showed stronger upside price pressures in contrast to the latest PPI report released yesterday.

I don’t have time to cover everything, but in general the news from all sides was positive and upbeat today… everyone from Intel, to the credit card issuers, to the Fed all hitting the markets with happy and optimistic rhetoric. In the FOMC minutes the Fed said the end of the recession is in sight and they raised their forecast for inflation which the market reacted to positively.

The short-squeeze factor is fairly cut and dry… when you take the rise in points and percentages of the S&P 500 and Dow and compare them to the trade volumes, it’s clear today’s strong gains were made on historically low volumes which is a signal the bears were forced to cover their shorts and actual buying conviction was somewhat lacking.

I’m not crediting all of today’s gains on Wall St. to a short-squeeze but consider just a few days ago the masses were screaming about a so-called “head and shoulders” pattern that was supposed to mean equities were going to nosedive but ever since then they have gone up. It’s the same exact scenario from a few weeks back when the masses were going on about equities breaking above their 200-day moving average and then they tanked, causing the bulls to cover their trades.

The EUR/USD held a very strong positive correlation to equities, crude oil, and especially gold. At 0130 EST Wednesday morning both the S&P 500 futures and spot gold reached a bottom and moved up strongly and that was the point the EUR/USD turned up and never looked back. Commodity currencies like the USD/CAD and AUD/USD also benefited mightily from strong gains in crude, gold, and equities, moving a few hundred points to the upside.

From the looks of things, as long as the news stays good, the numbers beat expectations, and the fundamentals do not shock to the downside, the euphoria will continue. I’m not about to predict when it will end and I’m not exactly sold on the idea of an almost instantaneous recovery of the global economy that took five years to destroy, but no matter what, the markets are always right… tomorrow is a new day and anything can happen.

Rome is still burning:

Apparently the Fed and FDIC are still operating in the “too big to fail” realm… CIT, one of the biggest commercial and consumer lenders in the US, is about two steps away from a total collapse. Unless the government saves the sinking ship, CIT will lose its own access to credit and funding, will default on its debts and will be unable to operate. Somehow the market’s attention has been mostly diverted away from this situation but when you consider how big and how important a player CIT is, the situation looks dire and could have far-reaching affects.

CIT lends and offers funding to a base of over 1-million commercial and consumer customers. They have a big retail customer base of over 300,000. Just through the Small Business Administration, CIT made almost $767 million in loans last year, and as of March CIT had $1.5 billion in available credit lines for its customers. Back in December the Fed gave CIT a $2.33 billion bailout. In the past 2-years CIT has lost well over $3 billion. So, where’s all the money at and why are they on the brink of bankruptcy?

CIT has been around for about 100-years and they used to be the #1 independent commercial lender in the US and the root of the problem lies within their ability to service their own debt and creditors. In exactly one month CIT has a $1 billion debt obligation to meet and they can’t do it, they will default unless the Fed and FDIC bail them out yet again.

If CIT does fail, the impact on the already battered retail, manufacturing and small business sectors could be brutal. We’re talking about more job cuts and more bankruptcies in those sectors. CIT cannot get credit because their credit ratings have been slashed but they need credit to meet their debt obligations… that is the net bottomline issue for CIT.

I am expecting CIT to get another bailout and we should probably hear a resolution within the next 24 to 48-hours. Once again the US taxpayer will have to cover this one. At this it seems like the market could careless, they are too busy riding the earnings euphoria wave but should CIT’s bailout fall through for some reason, it’s very possible the markets react negatively to this situation.

Thursday trading:

Once again, Wall St. will remain the center of the universe tomorrow as both the Forex and commodity markets take their cues from how the S&P 500 and Dow indices are moving. There are a ton of earnings reports being released before the bell on Thursday morning, including JP Morgan. After the bell there are two monster reports from IBM and Google.

Tomorrow’s big fundamentals are mostly out of the US and include Initial Claims, TIC, and the Philly Fed. If the data is bad it will likely be ignored as long as the earnings look good and there are no big downside surprises. These markets are all about confidence and fear… the news and data is giving the confidence and those that were looking for equities to roll over based on a technical pattern are trading on fear, so they have to keep covering their shorts and that will push prices higher.

For Thursday, the fate of the yen and dollar and their higher-yielding counterparts will be squarely on how the S&P 500, crude oil and gold move. Back between 2-June and 11-June the S&P 500 futures run after run at the 950 level and each time it failed to sustain above there and move higher. For what it’s worth, unless the emotions of the markets suddenly change based on some bad news or fundamentals, I believe we are headed back to test that resistance zone. A sustained break of the 950-970 levels would put the S&P 500 in somewhat unchartered territories and then things would get very interesting. 

I’ve been doing a lot of watching and waiting so far this week, I don’t like to trade or put much risk into markets that are running on pure emotion as the downside reversals can come just as quickly and violently as the upside gains. If in doubt, sit it out… there will always be another opportunity to trade in the future. 

One event I will be closely monitoring and which could impact the markets is former Treasury Paulson’s testimony before congress. Paulson is a flatout liar and crook and was one of the chief architects of not only the economic meltdown but most of the major bailouts courtesy of the taxpayer. I believe his testimony is set to begin at 0900 EST or sometime there after. Paulson will stick with his lying ways and nothing will get resolved but at least it will be fun to watch him get emotional when congress grills him. 

Finally, as I’ve mentioned a few times in the prior updates, it’s important to keep up with the bigger Chinese fundamentals as a lot of focus and attention is on China and China’s ability to help end the global economic recession. At 2000 EST this evening we get Chinese GDP, Industrial Production, CPI, and PPI. Somehow the Chinese data will almost always magically meet or beat their forecasts, so if we get some hot numbers out of China we could easily see the equity futures rise, the Nikkei jump and more downside pressure get put on the dollar and yen.

Take care and happy trading.

-David