Market Update

At the beginning of last week I wrote that the markets were in for a risk-off week due to some incoming bad data.  The data was bad and stocks did have a very rough week.  One would think then that the dollar would be showing some strength as investors rebalanced their portfolios towards cash and moved money away from risky assets like the Euro, which is currently managing a debt crisis.

In fact the opposite happened, and the dollar got killed.  I made some great money shorting stocks, but the week was basically a wash against what I have left of my dollar longs.  Although the breakdown in this correlation is not unprecedented, last week it was very dramatic and I find that to be important and worth my attention.

There is a disaster scenario in the back of my mind that the end of QE2 could bring falling prices for both stocks and bonds, as the largest buyer of Treasuries leaves the market and stocks lose the supportive "Bernanke Put."  Many large funds (PIMCO, for one) are currently short Treasuries on expectations that there is no real demand for them beyond the Federal Reserve.  Last time QE ended though, the demand was found in the flight to safety trade as investors moved from risky assets to safe assets because return on investment is not nearly as important as protecting the principal itself.  But it is very worrying when investors don't seem to consider the dollar a safe asset anymore.

S&P 500 Index vs. EUR/USD

So is the Euro going to chase stocks to the downside?  I doubt it.  The Euro's strength has been surprising, but there is no short-term divergence on the interim highs and we're already past the 62% retracement.  That leads me to conclude that the head and shoulders pattern is busted and we're headed for new highs in the Euro.  This is supported by the non-divergent peak on the daily charts for the last high at 1.49.

The ECB meets on June 9th.  Trichet did not use the "strong vigilance" phrasing against inflation at last month's press conference, and the Euro sold hard off the last interim high..  So a rate increase is currently not priced into the market, but one is expected for July so many will be expecting to hear those words for next month's meeting.  I think the market is also expecting to hear something about a debt agreement for Greece, but there are a couple of roadblocks to that.

EUR/USD Hourly

EUR/USD Daily

The Commitment of Traders report shows speculators are edging back into the Euro, but dollar short covering is continuing.

Currency Commitment of Traders Report

Stocks still look terrible.  We have broken a major trendline and failed hard on a backtest.  There is an obvious target at the open gap just below at 795.  Probably a good short term "dip buy" spot.

Russell 2000 Index Daily