Markets Shrug Off Geopolitical Tension

by Marc to Market

The US dollar is trading heavier against the euro, sterling and yen, but is somewhat firmer against the dollar-bloc in mostly subdued activity.  

Full liquidity will not return until next Tuesday. 

Sterling is trading at new 4-year highs today. After the strong employment data, more participants are looking for a test on the $1.70 level and above. For its part, the euro has built a base this week near $1.3800 and appears poised to return to last week high just above $1.3900.  

There have been three developments from the Europe to note.  First, excess liquidity appears to have risen in the Eurosystem.  At 132 bln euros yesterday, it is the highest since mid-March.   This may help stabilize EONIA.  One of the consequences of this is that the ECB is more likely to be able to sterilize the SMP holdings next week after failing to do so this week.  

Second, EU March auto sales rose for the seventh consecutive month.  The 10% increase brings it to 1.49 mln units.  UK sales rose 18%, and this accounted for about a third of the EU increase.  Recall that in 2012, the UK surpassed France as the second largest EU car market after Germany.  German sales increased 5.4%, encouraged by an increase in discounts.  

Third, France appears to have won a sympathetic hearing from EU about marginally slowing its deficit reduction efforts.  It is not exactly clear what this really means, as France has consistently overshot its deficit targets and has received forbearance more than once.  Moreover, Finance Minister Sapin promises that the fiscal targets will be respected.  Note that next Wednesday, France is to provide details of its long-term deficit reduction intentions.  

The main news from the Asia was China's announcement of a cut in required reserves for "qualified" rural banks.  The effect of this was to push down money market and swap rates.  Blunting this was the PBOC draining operations.  This week, it drained about CNY44 bln after injected about CNY55 bln last week. Some banks are looking for a cut in the required reserves for large banks later in the quarter (May or June). The dollar initially rose to its highest level against the yuan (~CNY6.2295) since March 21 before pulling back to finish little changed on the day (~CNY6.2190).

Against the yen, the dollar remains within yesterday's trading ranges.  Although as widely expected, the government did trim is economic assessment in light of the sales tax increase.  However, anecdotally, it seems that the economy is withstanding the increase better than expected.  This is what the finance minister indicated yesterday, and this appears to have been confirmed by the Reuters "Tankan" survey, which found the largest jump in sentiment among the large manufacturers since August 2007.   This coupled with anecdotal reports of businesses raising prices in excess of the retail sales tax would seem to undermine the likelihood of additional policy responses anytime soon.  

The highlights from the weekly MOF flow data include foreign investors returning to sell Japanese equities, after last week's hiatus after four weeks prior of selling.  The equity sales were more than offset by purchases of bonds and money market instruments. After having a voracious appetite last year for Japanese shares, foreign investor demand has cooled considerably and thus far this year, foreign investors have been net sellers.   They have sold a weekly average of JPY169.5 bln.  For their part, Japanese investors bought foreign bonds for the first time in four weeks.   They have sold a weekly average of JPY337 bln of foreign bonds this year.   

In the North American session, there will be some interest paid to the weekly initial jobless claims.  Recall last week, they fell to new cyclical lows of 300k and the smoothed 4-week average (316k) is approaching the cyclical low set last September (~305k).  Additional declines this week and it will likely spark talk of greater than 200k increase in April non-farm payroll.  

At the same time, Yellen was very clear yesterday: there remains a large gap between the Fed's objectives and the economic performance, especially the labor market conditions.  She suggested (for the first time?) that it may take until the end of 2016 to reach the Fed's inflation and employment targets.  She also continued to warn that inflation risks were still to the downside.  

Lastly, we note that the US, EU, Ukraine and Russia are to meet today.  However, a diplomatic solution seems unlikely at this juncture.  Indeed, the diplomatic effort, including by Germany exploring back-channels, has failed.  Another round of sanctions seems increasingly likely.  Putin appears to be betting that Europe and the US will not have the stomach for a sustained tough sanction regime.  Already reports suggest that many European businesses are cautioning against imposing new sanctions.   

Nevertheless, the markets do not seem to be particularly worried ahead of the long holiday weekend.  Gold remains heavy, straddling the $1300 area, nearly 2% off last Friday's high.  The euro remains firm, having made a marginal new high for the week.  The rouble is posting some corrective upticks after slipping earlier in the week.  Russian stocks are little changed, and Russian bonds are firmer.    

Impact of EU's Credit Rating Downgrade

On Friday, Standard & Poor’s (S&P) downgraded the credit rating of the European Union by one notch, from AAA (its highest rating) to AA+. The S&P believes that the EU’s overall creditworthiness has started to decline as tensions rise during budget negotiations between 28 member states. Credit ratings measure confidence in the group's ability to repay its debt. When S&P lowers its ratings, it means the agency believes it has become harder for a group to repay its debt. This, in turn, can affect a country’s ability to borrow money. Essentially, a lower credit rating translates into a higher interest rate which means its cost more to borrow money!


This is not the only negative news for the eurozone. Growth is expected at 1.1% and the unemployment rate at 12.2% for 2014. Despite the news, price action in the Euro has remained relatively muted. EUR/USD saw a small decline on the weekly chart. A reversal of EUR/USD could be in store if budget negotiations continue to stall.  

Chase That Trade

Trading with your emotions in check is an absolute fundamental when you are involved in the markets.  Sometimes though, it is easy to get caught up in the whole "rush" with everyone else and look to trade even though necessary "precautions" have not yet been established.

The term "chasing the trade" essentially describes a trader who sees a price action accelerate higher and higher at which point he or she, ignoring risk and indicators saying otherwise, decides to buy into this "great" deal hoping that their trade makes profit, because everyone else is profiting from this trade too right?  So why can't you?

Chasing any trade is dangerous for that matter as usually, if you've "missed out" on the first big price move it is questionable if you will actually take a profit in the long run.  The higher the price level goes, the closer it usually gets to overbought levels.  Overbought levels must be looked at in great detail, of course unexpected moves can jolt the price higher, however the more overbought a trade becomes, the more likely a violent drop and price correction will happen, something that you may not be ready for, especially if you get in on a "late" trade still thinking you'll make a gain.

Is it wise to enter a trade late when the price has already risen fairly rapidly and it is in danger of being overbought?  Or is it better to hold back and be more risk averse?
These questions may be answered depending on what strategy you use and your investment goals you've established for yourself though adding technical indicators such as the Relative Strength Index (RSI), the True Strength Index (TSI), and even the Moving Average Convergence/Divergence indicator (MACD) to your existing strategy would definitely be a solid addition especially to counteract any trade chasing you may feel tempted to partake in.

Just remember, the higher and more dramatically a price rockets upward, more likely than not its being overbought and a pullback i.e. price correction, is just waiting to happen.