ECB interest rate comments hammer euro:

The sharp drop on the EUR/USD on Monday afternoon was a gift from ECB Ewald Nowotny. He wasn’t the only ECB member that gave strong rhetoric on interest rates today, there were more and we’ll get to those in a moment. But here’s what Nowotny said to send the euro plunging against the dollar and yen:

‘ECB rates to stay low for a long time. ECB ready to use quantitative easing if needed’

Nowotny’s comments hit the news wires at 1300 EST and within just one 30-min EUR/USD timeframe the euro opened lower by 105-points and it was a beautiful move.

If you remember last month Trichet hinted to the markets that 1.00% was basically the ground floor for the ECB’s key lending rate but now as we get closer to next week’s ECB rate decision we’re starting to hear otherwise from members on the governing council. One of the main reasons the euro was able to recover and stay fairly well support over the past week was due to the fact market participants were under the assumption the ECB was not going down the road of loose monetary policy and they would not take interest rates lower than 1.00% nor would they keep rates low for an extended period of time. So, the euro began moving up in anticipation of next week’s rate decision and the general thought that the ECB would not become the Fed. Time for some second thoughts…

Earlier in the day before Nowotny’s comments hit the wires the euro was somewhat supported above the 1.3120 level but struggled to continue higher and was unable to test and break the 1.3150 level after these comments by ECB Wellinck hit the market:

‘European Central Bank policymakers should discuss cutting interest rates below 1%’

After Wellinck’s rhetoric hit I was surprised to see the euro manage to stay above 1.3100 but I suppose the market was just doing as the market does… letting traders pile into the end of an upside move before turning it around on them. Wellinck went on to say:

‘This is part of a discussion we should have in the Governing Council. Of course that should be discussed’

Wellinck’s Irish ECB comrade, John Hurley, said:

‘I cannot exclude the possibility that the Council may — in a very measured way — further reduce the main policy rate’

But wait, it gets even better… Nowotny also said:

‘Sees disinflation in Eurozone’
Remember what I said about disinflation and how it would hurt the euro? Both sets of rhetoric from Wellinck and Hurley came out hours before Nowotny’s, so there was plenty of time for market participants to get out of their euro longs and get in on the short-side, and plenty of time for the brokers to collect more euro long contracts from their retail customers who don’t pay attention to the fundamentals and interest rate rhetoric.

That’s all I’m going to say on this stuff, I don’t want my commentary to sound like a childish “I told you so,” but the point I’m laboring to make is, if there’s any traders who do not follow central bank rhetoric, especially rhetoric on interest rates and inflation, now might be a good time to consider doing so because they are impossible to fight against.

Wall St. gets a touch of swine flu:

During the mid-morning session the Dow and S&P 500 were in the green and stayed mostly supported but as we got into the afternoon more reported cases of swine flu began hitting the wires and equities went from green to red… with each new report that hit the wires equities took a hit, it was actually pretty fun to watch. The S&P 500 futures made decent gains off their lows and were also strong into mid-morning NY but here again, as those swine flu outbreak reports gained momentum, correspondingly the S&P 500 futures gained just as much downside momentum.

As we talked about in the previous update, this swine flu thing is what I consider to be an unforeseen issue and a geo-political event that has a definite impact on the markets… it causes risk aversion which leads to a stronger USD and JPY, lower equities, higher Treasuries, and general weakness in commodities, especially those linked to agriculture and food. At this point I wouldn’t consider the swine flu issue to be a critical geo-political event until it’s officially declared a pandemic. For now, I’d say this is just spooking the markets and causing knee-jerk reactions.

Lessons in human behavior and price action:

I think today’s geo-political events offer valuable lessons for traders on exactly how human behavior impacts price action and price momentum in all tradeable markets. I’m going to expand on what I was talking about in the previous update now that all markets have had at least one trade day to digest the information and then respond…

In Forex whenever we have this type of geo-political event, the risk aversion aspect drives market participants to buy the USD and JPY while sending currencies like the AUD, NZD, CAD, EUR, and CHF lower. The question is, why would this happen? It has to do with how a global pandemic impacts growth and trade, specifically how it impacts GDP. America and Japan are considered relatively “safe” economies (don’t laugh) whereas places like the Eurozone and South America are considered less safe and generally carry a higher level of risk. So when there’s a situation like this one where GDP and global trade becomes at risk, human behavior drives money-flows into the “safer” currencies like the dollar and yen, and it’s all connected back to GDP.

For equities, it’s even simpler and clearer how human behavior drives price action… look at who won and who lost on Wall St. today:

  • Airlines – lost
  • Hotels – lost
  • Agriculture – lost
  • Pharmaceuticals – won
  • Health care – won
  • Biotech – won

Publicly traded companies that are in the travel and leisure sector, the farming and agriculture sector, and those connected to the agriculture commodity sector were hammered on Wall St. by market participants. On the flip side, this geo-political event brought the pharmaceutical, biotech, and health care sector surging back to life. It was like a total cathartic moment for names such as Novavax (+79% gain), Biocryst (+75% gain), Pure Bioscience (+56% gain), and Sinovac Biotech (+39% gain).

I’m not a stock trader or stock expert but I don’t have to be, this is pure human behavior at work and a brilliant example, courtesy of the markets, for how fear and greed drives humans to make the decisions they do and how those decisions drive price action. Even though this is a lesson on a grand scale, it’s exactly how I trade FX on a daily basis, it’s no different at all because every trade day there are events just like this one, mostly on a smaller scale, that cause price fluctuations in the Forex market and the markets that make-up it’s correlated variables.

Take the plunge in the EUR/USD as another example. We had a geo-political event that involved central bank rhetoric on interest rates. That single event caused market participants to react, it drove humans to make decisions and those decisions had a direct impact on price. It wasn’t because the euro hit a Fibonacci line or a pivot point that it instantly decided to drop over a 100-points in a matter of minutes… and the great thing about Forex is that these types of events happen almost every day and we traders can capitalize on them in addition to capitalizing on the reaction that comes after those markets have over-extended and exhausted themselves.

Tuesday trading and fundamentals:

OK, so Wall St. ended the day lower, however, the S&P 500 and the Dow were able to sustain above key support levels despite a stronger dollar and yen, weaker crude and euro, stronger Treasuries, GM announcing 21K new layoffs and taking their Pontiac brand out to the field to be shot like an old cow, and the potential start for a swine flu pandemic which would put a serious hurting on the already fragile global growth situation. Not too shabby.

Those are the kinds of reasons why I’ve been saying Wall St. equities should remain supported into the first of May, but I’m not going to call this anything other than a bear market rally, I’ve not changed my mind on what I think these moves in equities are. The main reason I see risk on equities starting sometime in May and especially as we get into the summer session is because of the utter lack of liquidity and lack of market participation that will hit the markets in the coming weeks.

The S&P 500 and Dow aren’t surging topside like they were just two weeks ago but I think the bears are pretty freaked out right now and are too scared to hammer stocks like they did prior to the start of the bear rally on 10-March. There are a lot of bears out there and I believe if summer trading conditions are favorable to potentially send Wall St. lower, the bears are going to jump on the opportunity once they see equities beginning to fracture. And as that fracture takes hold, you know how it goes… all the bears pile in short, drive stocks lower, then the bulls freak out and start panic-selling, and that puts a lid on the bear market rally and we test lows and support levels.

Tuesday fundamentals–

Tomorrow is a big day for all markets because we get two key pieces of fundamental data: S&P/Case-Shiller Index and even more importantly, US Consumer Confidence. In my view, the world is depending on American consumers to help turn the global financial turmoil around. It won’t be consumers in Asia, Europe, or other emerging markets. They don’t have the buying power to make it happen, it’s up to the good ‘ole American consumer. I don’t care what some analysts are saying about China being the economy that ends the global recession, I’m not buying it. If anything the Chinese could hurt the situation if they get serious about selling the USD and discontinuing their purchasing of Treasuries.

I don’t have a forecast for Consumer Confidence because I don’t even halfway trust any of the data we’re getting from the government. That being said, the recent trend with this type of data, i.e. data that makes everybody happy, has been to print better than expected, so I suppose we can expect a happy number.

Euro fundamentals and euro risk–

Tomorrow we get German regional CPI prints and these will be important to watch for one specific reason… can you take a guess why? It’s something we’ve been talking about for the past few weeks and which was noted by our friend Nowotny — disinflation. I believe if the markets see disinflationary conditions it’s only going to serve to further pressure the euro. The other risk for the euro is continued verbal manipulation from the ECB to knock the euro lower and prepare the markets for some surprises at the next ECB meeting. Even Trichet is starting to hint at unveiling what he calls “non-standard” measures at the next meeting.

Swiss risk–

At 1100 EST / 1600 GMT, SNB Roth is scheduled to speak in Zurich. The reason why Roth’s speech puts risk on the CHF is because it’s abundantly clear the SNB wants the Swiss franc to devalue as much as humanly possible. The market hasn’t really been cooperating to meet the SNB’s desire for a weak and devalued CHF, so that means a central banker like Roth could use an opportunity like this to hit the markets with verbal manipulation to send the franc lower, so be on the lookout for sharp moves with the EUR/CHF, USD/CHF, GBP/CHF, and EUR/USD during his speech.

Geo-politics and USD Index–

Geo-politics is the biggest risk facing all markets right now. If the swine flu situation gets declared a pandemic, look for equities to get hammered and risk aversion to take hold in the markets. All the major currencies are at risk of rhetoric and verbal manipulation, especially the CHF and EUR respectively. Spot crude’s still flirting with the $50 level and its price action will also weigh positively or negatively on the markets based on whichever direction participants decide to take it, keep your eye on that correlated market.

The other factor is the USD Index and how these geo-politics will impact that key correlated market… it did gain some ground today but ran into that old resistance level around 86.50. In my view, the USD Index is sorta stuck between 84 on the bottom and 87 on the top. Those support and resistance levels will need to sustain a break in order for the majors and yen crosses to break out of their respective ranges.

Alright, that should give us plenty to think about over the next 24-hours. As always, be smart and savvy with your risk and money management.

-David