ECB and Trichet hawkish, sends euro soaring:

For all the hype and speculation about what the ECB could do in regards to their ‘non-standard measures’, Trichet and the ECB revealed a program that is not even remotely close to what the Fed and BOE are doing. Initially during the first few moments of Trichet’s press conference he made the announcement the ECB would buy euro denominated covered bonds but gave no detail other than calling the program, Enhanced Credit Support Operation.

The initial announcement and complete lack of clarity hammered the euro because it did sound like a quantitative easing-type program. Within 8-seconds of Trichet making this announcement to buy covered bonds the euro went from the 1.3340 level to the 1.3250 level, but then the euro rocketed back up after he said the details of this program would not be released until June. After giving market participants a reprieve, the euro quickly recovered above the 1.3400 level as this program was further explained and market participants realized it is not a program to monetize government debt, but to support and stabilize the European banking system.

This new covered bond buying operation was priced at around $60 billion euros and the technicalities will be revealed at the next meeting in June. Trichet said, “$60 billion euro is an appropriate level to help meet objective”.

The key thing is, the buying of covered bonds is not a quantitative easing type program, it is not monetizing government debt, it is to stabilize the banking system, loosen credit and lending, and to stimulate the economy with the main objective to get banks to lend more to the public sector. Trichet went on to say no other decisions at all were made to buy bonds and that the decision to embark on this new program was made unanimously by the governing council. Trichet made it clear they were not embarking on a quantitative easing program.

The euro was further supported by Trichet’s comments on interest rates. On the future of interest rates Trichet said:

Current rates are not necessarily the lowest they can go, but sees the current level of interest rates as appropriate”

What Trichet told the markets on interest rates is that there will be no rate cut in June. That is very hawkish and helps maintain the euro’s higher and generous yield against the dollar. And then the markets got hawkish rhetoric on the Eurozone’s fundamentals. On economic conditions Trichet said:

“Latest data suggests tentative signs of stabilization; we see there is stabilization; Q2 will be much less negative than Q2”

On inflation Trichet said:

“Inflation pressure has been rising”

That comment right there was said to put any fears of deflation or disinflation to rest. So between Trichet clearly stating the ECB would not monetize government debt, putting a floor in interest rates, the S&P 500 futures and S&P 500 making strong initial gains, the USD Index getting hammered, spot crude going to $58+, and the 10-year yield surging to 3.27% from a strong Treasury sell-off, the euro had no problem recovering to the 1.3455+ by 0930 EST… every single one of the euro’s market correlated variables was working for it, nothing was working against it as Wall St. opened this morning. It wasn’t until Bernanke’s comments about broader government oversight around 0956 EST that the S&P 500 futures sold-off, pushing the USD Index off of its lows which slowed the pace of the euro’s rise and took it back under the 1.3400 level.

Overall, Trichet was the most hawkish and upbeat he’s been since last September and market participants were totally buying in to it. Not only was Trichet’s strong hawkish rhetoric and tones positive for the euro, the fact the ECB didn’t go down the route of the Fed and BOE in terms of monetizing government debt was highly euro supportive. After Trichet clarified exactly what the covered bond buying program was, there was not a single comment or piece of rhetoric that signaled any reason to sell the euro against the dollar. It was Bernanke’s odd comments that hurt the euro via the euro’s strong correlation to equities in addition to a wrecked Treasury auction.

Bernanke rattles Wall St. and causes sell-off:

In his usual mind-numbing manor, Bernanke delivered a message to Wall St. that they did not want to hear. Bernanke spoke to the Chicago Fed this morning as Wall St. was getting up and rolling and his comments on increasing regulation on banks, reversing repurchase programs, monitoring liquidity risks, and formulating an exit plan to end credit support to the markets stopped Wall St.’s strong open dead in its tracks and caused a nice sell-off. His alarming rhetoric brought risk aversion back into the markets, sending money flows back into the USD, JPY, and Treasuries and right back out of the EUR, GBP, AUD, and CAD. That’s just the way it works… Bernanke really hammered the S&P 500 futures, sending them down over 20-points within the first 2-hours Wall St. was open.

But, in my opinion there’s a little more to the story today with what happened on Wall St. and the equities sell-off…

Botched Treasury auction brings risk aversion and USD strength:

I’m not sure what kind of headlines this is getting, but this afternoon there was a 30-year bond auction that went awry, it was ugly. Within minutes of the auction results being released the S&P 500 futures, S&P 500, and Dow all came under renewed pressure as market participants quickly digested the results and flat out stopped buying equities.

Now typically the lack of demand for Treasuries is a good thing for Wall St. because under normal circumstances it shows that market participants are willing to send their risk and money-flows into stocks and not bonds, but that was absolutely not the case today. On the contrary, this is how market participants show a vote of ‘no confidence’ in the longer-term outlook and potential performance of the US economy. How market participants send their money flows into Treasuries is a beautiful gauge of how participants view the viability, growth, profitability, risk and safety of the US economy and US government.

Market-movers who participated in today’s Treasury bond auction, which is the longest dated maturity offered by the Treasury, forced the government to pay them higher yields in order to park their money for 30-years. Participants were basically telling the Treasury that if they want their money, they’ve got to up the yields, payout more money, and then they’ll buy the government’s debt.

Although what happened at today’s auction is a bit of an anomaly, this shouldn’t come as too much of a surprise if you recall what I wrote in the 26-April update:

In my view, the days of the great Treasury bull run should be officially over. Treasury prices should be starting their march back down while yields should be starting their march back up. Treasury supply should far exceed demand and all of those factors are nothing but bearish for Treasuries.

The results of today’s 30-year bond auction were nothing but bearish. In fact, all Treasuries are going extremely bearish just as I expected they would. After today’s abysmal auction the benchmark 10-year yield skyrocketed to almost 3.35% after trading around the 3.00% level last week. This is some nasty stuff for the government to have to deal with because with all the untold billions of dollars they need to raise to fund their stimulus programs, now the markets are forcing them to pay more to borrow and that puts US debt at even greater risk. Anyway you slice, it’s bad, bad, bad…

Using these fundamentals for trading–

This is one of those fundamental events that has a direct impact on the Forex market and how participants in our market handle their FX positions. For me personally, the first thing I think of is, “how will this fundamental event impact market sentiment, risk, and how participants will react, which then impacts price action and price behavior”.

So in this case, after digesting the dismal auction data and figuring the impact would be negative on equities, it caused me to take profit on a GBP/JPY long position. Reason being, my position was in profit, and of course profit is always nice, but knowing that when the S&P 500 comes down, the yen goes up, so I also acted to prevent my position from going into drawdown.

And it’s really that simple. Explained another way… lack of Treasury buyers, which force yields higher, translates to negative sentiment, which leads to risk aversion, which then takes the S&P 500 lower, which then pushes crude oil lower, the USD Index higher, and then the dollar and yen gain on the FX market. That’s the exact scenario and process that goes on in my mind and then correlates to how I handle any open positions that would be net USD or JPY short in addition to how I take new positions to play this fundamental event and the fundamental factors. In this specific case, as I mentioned, I closed a GBP/JPY long, which is the equivalent of being of being JPY short, thus preventing my position from going against me or decreasing my profit potential.

Non-Farm payrolls to show 16th consecutive month of job losses:

After a long week of mega fundamentals and heaps of central bank rhetoric, we’ll go out with a bang as we get the latest NFP and Unemployment Rate data. Now there is some important Eurozone data before NFP, but the only I’m focused on and the rest of the market is focused on is the jobs data. That’s all that’s going to matter for tomorrow.

Here’s what the bank economists and bank analysts are forecasting for NFP and the Unemployment Rate:

NFP consensus range: -580K to -810K
Unemployment consensus range: 8.5% to 9.5%

As always, the geniuses at the banks have a nice and tight range there… anyway, my personal forecast is as follows:

NFP: -562K
Unemployment rate: 8.9%

I’m not at all a news trader but NFP is the one news event I seek to trade each month. I don’t believe NFP itself, no matter how bad the print is, would be enough to knock Wall St. back too far, but I do believe that should this evening’s stress test information further spook the markets on top of what Bernanke did to them earlier in addition to the botched Treasury auction, that a poor NFP print will lead to profit-taking on Wall St. And it’s the profit-taking combined with the lack of conviction volume buying, and then the stoploss triggering which could bring Wall St. lower tomorrow.

Between what Bernanke had to say and how the Treasury debacle caused risk aversion, Wall St. will be going into tomorrow’s NFP event in a rather grumpy mood after being euphoric for most of the week. The S&P 500 was getting over-extended anyway, so there’s certainly plenty of reason to see the profit-takers come out and the big, bad bulls sit on the sidelines. Now should we get a nice upside surprise on NFP, which is certainly possible based on recent US data trends, it may bring in some renewed confidence.

For us in the currency market this means the potential for volatile and chaotic price swings and sharp moves. As much as I love trading NFP, if I think market conditions may cause me to give back any of the profits I’ve made this week, I’m not trading it, plain and simple. Friday’s are the day the largest majority of traders lose and give profits back. So for me, sometimes the best way to win is not by trading at all…

If you do trade FX during the NFP news events, pay close attention to all the correlated markets… if money-flows pour back into the S&P 500 and S&P 500 futures, we’ll see spot crude gain, the USD Index come lower, and non-risk aversion money-flows head into the EUR, GBP, AUD, and CAD, and back out of the USD and JPY.
Trading–

At this point my own personal risk and money management plan still calls to not buy the USD or JPY, and to short them against the majors and crosses when my 30-minute data, price patterns, and the correlated markets show. Even with the volatility today, not buying the dollar and yen and shorting them against the majors and yen crosses was a profitible plan, so while it’s working and paying out, I’m sticking to it.

The USD and JPY remain in very terrible fundamental condition currently and as long as equities and commodities continue moving north with the help of heightened risk demand for higher-yielding markets, the USD Index will keep moving inversely against the S&P 500, just like we talked about in the Sunday update.

NFP risk management–

Don’t forget that between 1700 EST and 2030 EST there will be a heightened potential for stop runs and stop loss triggering in the market, so be on the lookout for that. Also, as Tokyo is closing and Europe enters the market there will be book squaring and positioning ahead of the NFP event, and then again when Chicago futures money hits the market before NY opens. Be smart with your risks and be aware of what time of day it is so you don’t get caught off-guard and take an unneeded loss.

That’s all for now. EUR/USD key levels will be posted in the morning before NFP. The best risk management advice I can give all traders, especially those who are under capitalized is: DO NOT TRADE NFP

-David