Recently in Trader Education Category

During last week's trading we all saw what kind of impact the earnings reports and the moves on the S&P and Dow Jones had on the currency, commodity, and bond markets... for the week ahead I expect to see the same exact themes play out as news, data, and fundamentals remain the witch's brew of choice for the big money market movers.

Last week approximately 25% of earnings were released but over the next two weeks we get the other 75%, so do not expect any change in how those events act as the catalyst in the Forex market and Forex's correlated markets. Over-the-top earnings from the likes of Goldman Sachs, Intel, IBM, JP Morgan, and Bank of America led to a 7% gain on the S&P 500 and the Dow surging up 7.3%. The strong upside gains on the US and European equity markets sent crude oil up 6%, gold up over 2%, and Treasuries to their first decline in 6-weeks.

Market participants sent their money-flows out of Treasuries and back into equities with measured conviction as we saw the yield on the 10-year note rocket up 34bps. In this weekly outlook I'm going a little more in-depth about Treasury yield curves, specifically between 2-year and 10-year notes, because the spread and yield curve between those two key debt issuances can often times reveal quite a bit about the overall risk appetite of market participants and how they gauge the potential for future growth of the US economy.

Last Thursday world famous market bear, Nouriel Roubini, gave participants yet another incentive to buy up equities and to sell the dollar and yen as he said the worst of the financial turmoil is behind us and he expects recovery by the end of the year. Although he did say another stimulus package would be required to combat the seemingly unstoppable rise in unemployment.

So, is any of this real? Are the global financial markets really recovering and is everything really fixed? I personally do not think so, I believe another tsunami wave could hit the equity, commodity, and Forex markets later this quarter or in Q4, but it doesn't matter because in this game perception is the reality... the recovery is as real as the markets want it to be and make it out to be. The thing I have to constantly remind myself is, the markets can stay irrationally exuberant for an indeterminable amount of time.

Fundamental events moving the Forex and equity markets this week:   

This week's fundamental and economic calendar is a little lighter than usual for US data but for European data there are a number of critical fundamental events that center on inflation, the consumer, production, and manufacturing.

Bernanke testimony--

For the US dollar the bigger fundamental events take place on Tuesday and Wednesday as Fed Bernanke testifies before the House Financial Services Committee and Senate Banking Committee in DC. Bernanke's testimony will be on past, current, and future Fed monetary policy (interest rates), the state of the US economy, inflation/deflation, the housing and employment sectors, the deficit, sovereign debt monetization, future stimulus measures and the prospects of a sustainable recovery on Wall St.

All markets and all participants will be watching the Bernanke testimony and reacting accordingly. Remember, back in mid-March it was Bernanke who was one of the main catalysts that stopped the plunge in the equity markets, turned the S&P 500 higher and sent the dollar falling back off the throne it temporarily inhabited. Bernanke coined the stupid phrase, "green shoots", and the markets ran euphorically with it. Recent Fed rhetoric has been positive, upbeat, and the FOMC has upwardly revised their growth and inflation expectations. 

Not all the members on those congressional committees are buying into the idea of an instantaneous recovery, especially Ron Paul and Jim Bunning. What traders need to be watching is whether the overall sentiment of these testimonies is more on the positive side or on the negative side in terms of the future prospects of the US economy because the money-movers in the equity, commodity, and Forex markets will take their cue from Bernanke's messages to congress and how those congressional committees react.

Key EUR/USD fundamentals--

• German PPI (Monday 0200 EST)
• Fed Lockhart speech (Monday 1330 EST)
• Fed Bernanke testimony (Tuesday 1000 EST)
• Eurozone Industrial New Orders (Wednesday 0500 EST)
• Fed Bernanke testimony (Wednesday 1000 EST)
• House Price Index (Wednesday 1000 EST)
  
• Crude Inventories (Wednesday 1030 EST)
• Initial Claims (Thursday 0830 EST)
• Fed Tarullo speech (Thursday 0930 EST)
  
• Existing Home Sales (Thursday 1030 EST)
• German Manufacturing and Services PMI (Friday 0330 EST)
• Eurozone Manufacturing and Services PMI (Friday 0400 EST)
• German IFO (Friday 0400 EST)
• Michigan Sentiment (Friday 0955 EST)
  

Pound sterling fundamentals--

I don't usually talk about the GBP much but after looking at the UK fundamentals I see there are a few events that carry a lot of market-moving potential. If you trade the pound sterling you'll want to be aware of the following fundamental events:

• M4 (Monday 0430 EST)
• BOE/MPC Meeting Minutes (Wednesday 0430 EST)
• Retail Sales (Thursday 0430 EST)
• BBA Mortgage Approvals (Thursday 0430 EST)
• Preliminary GDP (Friday 0430 EST)   

Also, both the BOJ and RBA release their monetary policy meeting minutes on Monday. On Tuesday the BOC has an interest rate event and monetary policy statement and traders will want to watch out for any rhetoric from the BOC to cool the CAD down. It can't really be possible to slow the CAD's appreciation as long as the S&P 500 and crude oil continue gaining but the BOC probably isn't too happy with the sharp reversal of the USD/CAD, so there is always a potential the BOC could do some verbal intervention this week.

Equity earnings reports--

Unless you've been on holiday or hiding in a cave I'm sure you're well aware of how the various earnings reports on Wall St. are moving the markets. We got just a taste of that last week and the response from market participants was resoundingly positive. Of course it's possible there's no real conviction behind the strong upside gains as volumes have been lighter overall. Plus, the potential always exists that the smart money is just waiting for higher prices to grab short positions to ride the next down move, but either way, as long as earnings meet or exceed expectations, the S&P 500, Dow, crude, and gold should continue higher while the dollar and yen remain pressured.

All week long, both before and after the bell, there are a massive amount of earnings reports scheduled for release and from big household names like Texas Instruments, Caterpillar, Coca-Cola, DuPont, Apple, Morgan Stanley, Wells Fargo... too many to even list. You can check the schedule here.

What this will likely translate to is a good deal of choppy and erratic price action on the S&P 500 futures and S&P 500 cash market, the Dow/Dow futures and then of course back into the currency market. The Japanese yen has shown extreme sensitivity to the moves made on the US and Japanese equity markets and I expect that trend to continue this week. The EUR/JPY is the benchmark currency pair that's most correlated to the S&P 500 futures and S&P 500 cash market while the GBP/JPY is moving in tight correlation with the Dow, Dow futures and USD/JPY. So, if you trade the majors and yen crosses this week be mindful of what's happening on Wall St. and with crude oil.

The yield curve and interest rate spreads -- future predictors:

The business of predicting the future of any tradeable market is mostly an exercise in futility, especially under the current environment where there is zero established trend and where the vast majority of participants alter their money-flows based on news, data, and emotional impulses.

A few weeks ago the upside break of a big moving average failed equity bulls and then a downside technical pattern failed equity bears, leaving many on Wall St. scratching their heads and hopefully a few figured out that stuff has zero to do with what moves markets. Participants who are purely fundamental have done a little better but even the strictly fundamental folks like Nouriel Roubini and Marc Faber are now changing their tune and I think they are doing so based on the trend of better headline economic numbers. But that's also a very dangerous game to play...

As fundamental as I am, I don't exactly trust any data that comes from a central bank or government agency. The way the data is compiled is a joke, it's unreliable, and beside all that, who can trust a politician or a central banker?   

In my evolution as a trader and during my quest for education on how to better understand the global financial markets and what they may do in the future, I'm learning to lean more on the bond market. Specifically, on how to use the relationship between the 2-year and 10-year Treasury note... how to gauge the future of the markets by monitoring the yield curve between 2's and 10's and what's happening with the spread between interest rates.

Yield curve--

Before I go any further I want to be clear that I am no expert on this stuff, I'm still learning and trying to gain knowledge in this regard, but I'm excited enough about this market correlation that I wanted to share it so other traders who want to learn the underlying fundamentals of what really moves markets can begin learning too. I'm a simple person so this will be a very simple explanation...

The yield curve is just a basic graph with a line that represents the difference in yields and the time in which the particular debt issuance matures. The benchmark yield curve for the financial markets is between Treasury debt that matures in 2-years and 10-years. 2-year notes are considered a shorter dated maturity and the 10-year note is considered on the longer end of maturity in addition to being most closely correlated to the US housing and mortgage market. In general, the longer the date of maturity, the higher the interest rate yield should be.

When analyzing the yield curve, market participants look at the slope of the curve, whether it shows a pattern of more of an upward or downward slope. Under most markets conditions the slope or shape of the yield curve should always be up or positively sloped. A down slope or inverted slope is an extraordinary situation, but we'll get to that in a bit.

How the yield curve and spread between the interest rates of 2's and 10's can be used in a predictive manner is based purely on the actual factor that determines the yield curve -- future expectations. Interest rates are the #1 key driver of all markets and the prospect of future interest rates are the #1 key driver of money-flows in and out of the Forex, equity, commodity, and bond markets.

Yield curve and economic growth--

When it comes to interest rates, market participants always put a risk premium on the future of rates. When the yield curve positively and upwardly steepens that is a sign that a greater majority of market participants have future expectations of better and rising growth. As the sentiment of market participants becomes more euphoric, more hopeful, and more positive, the yield curve steepens to the upside. This means interest rates are expected to rise because growth and economic expansion is expected.

But, with better growth and economic expansion comes the prospect for rising price pressures and greater price-related inflation. Because longer dated maturities like the 10-year devalue under an inflationary environment, market participants will force the Treasury to pay a better yield in order to take on the risk of holding a debt instrument that may devalue due to inflation. With growth comes higher rates, higher inflation, and therefore higher yields must be returned.

Yield curve and Forex--

If you see an upwardly steepening yield curve between 2's and 10's what you can glean from this is the market telling you the prospects for better future growth are rising. And what happens when prices go higher and inflationary price pressure tick up? Simple, higher prices equate to higher equity prices, higher commodity prices, lower bond prices and higher bond yields and all that translates into a weaker US dollar and Japanese yen.

Whether Wall St. admits or not, they absolutely, positively need price inflation and higher prices, and whether or not Forex traders realize it, higher equities = higher crude and higher crude + higher equities = lower dollar. Very simple.

Just last week the interest rate spread between 2's and 10's rose by a healthy 25bps. That means the yield curve between 2's and 10's upwardly steepened and maintained a positive upward slope and look what US equities did... they all gained 7% or more and the US dollar fell. If the trend of steepening yield curve between 2's and 10's remains intact I would expect to see the S&P 500 and Dow continue making gains while the dollar and yen stay pressured lower.

Inverted yield curves--

When the yield curve inverts or starts falling sharply or makes an extended downward pattern that is a sign of fear in the markets. If market participants think the economy is going to tank or fall back into a recession, the yield curve will invert. When market participants think there will be a season of devalued interest rates, which is a sign of slow or falling growth, the yield curve will invert. Also, if participants see much more deflation than inflation the yield curve can invert of slope downwardly. There is historical evidence that shows the yield curve will downwardly slope or become inverted a year or more before a recession hits the economy.

Now, this is a very rudimentary explanation of the yield curve and interest rate spreads and I'm sure there are much more in-depth commentaries on this issue, but my point is to encourage traders who want to get away from the unreliable lagging indicators to look at more reliable leading indicators for future moves in the markets.

Nothing is perfect or foolproof, but watching the 2's and 10's is something I plan on doing more in the future. Right now the future of any market is impossible to predict as participants are mostly running on the emotions of fear and greed and speculation of all sorts. I personally think we're in a deflationary environment but if the prevailing sentiment is that we're moving towards an inflationary environment then I need to trade accordingly because if that is what the market thinks, the market is always right.

Trading:

This is going to be another wild week filled with volatile price action, erratic price swings and generally choppy conditions. There is a lack of participation and a lot of very thin liquidity volumes in the Forex market, therefore, the price action in FX will be largely dictated by what's happening in equities and commodities. I expect the market to remain a very challenging environment to trade in this week.

All the markets will be opening and starting the week at elevated levels. Last Thursday the S&P 500 futures and cash market made one solid attempt at sustaining a break above the 940 level and unless we get some downside surprises fundamentally or geo-politically, I'm expecting to see 940/950/970 levels tested. The first week of June saw the S&P 500 make an attempt at busting through 950 but then crude oil fell off a cliff leading to an equities sell-off and boost of the dollar.

If crude oil can get back over $70 and make a run at $75 we shouldn't rule out the S&P 500 making a run to 980 or even 1,000. In that scenario the dollar would be under considerable downside pressure along with the yen. But in order for that type of scenario to play out, the news and fundamentals have be strong, the earnings have to exceed expectations and Bernanke and the Fed have to keep talking up the markets.   

In my view, Wall St. will remain the center of the financial universe and where participants in all markets will take their cue. Trying to even put a fundamental basis on price valuations for the euro, dollar. pound sterling, or yen is basically a waste of time at this point because their respective price valuations will be largely be based on risk appetites and sentiments in equities and commodities.

That's all I've got for now. I should be able to get back into the chat sometime mid week or as time allows. Have a great and profitable week and happy trading.

-David

For the week ahead the Forex, equity, and commodity markets will all begin trading at very key price levels and points of potential vulnerability. The S&P 500 and Dow Jones have been on a 4-week losing streak while their comrade, crude oil, dropped a staggering 10.2% in the prior five days of trading.

Granted, the lack of liquidity and thin market conditions associated with summer session trading have led to the sharp price action moves but in general we are seeing market participants come back to reality as they second guess the euphoria pumped into the markets by the central bankers back in April and May.

I am expecting a good deal of speculation to run rampant through the markets this week... speculation on whether crude will continuing falling to $55 or $52 or rise back to $65... speculation on whether the S&P 500 will go to 850 or 820 or rise back to 910... speculation on whether the US dollar Index will sustain a break above 80 and then 82 or if it will fall back to 78... speculation on how earnings will impact equities and the higher-yielding currencies... speculation on more potential stimulus measures... speculation on China's recovery and how that will affect the markets...

All the speculations will bring a continuation to the lack of any viable market trends, it will bring more daily or even hourly shifts in sentiment and risk appetites, and the general state of confusion in which all the markets have been operating the past few weeks. I have no predictions or forecasts for this week as there are a number of inflation, retail, consumer, housing, manufacturing, and central bank events which hold the power to toy with the emotions of market participants at any given moment.  

In my view the markets have shown growing concern for the state of the consumer, especially the US consumer, for the employment situation, and for the sharp slide in energy and commodity prices. Those issues will once again have to be dealt with this week and the end results will feed into where market participants send their money-flows.

From my own perspective I see that equities and commodities are more vulnerable to the downside as opposed to bouncing back to the upside. The path of least resistance has been down, not up, and the momentum has favored the downside. Of course this can all change in the blink of an eye but what I think will be required to shift sentiment and money-flows is for better than expected fundamentals or some confidence from the central banks.

It should be noted that even with the massive plunge in crude prices and the strong sell-off of gold, the dollar hasn't exactly surged against its counterparts. The US Index is above 80 but not by much, the EUR/USD hasn't even come close to testing the 1.3753 mega support zone and the GBP/USD has made a decent comeback off its recent lows after the BOE said they were not going to monetize more debt for now.

Market participants are still jumping on every little piece of news, fundamental data, and rhetoric from the central bankers and until we get bias one way or the other I expect the "trend" of no trend to be the trend.

EUR/USD fundamentals:

As I mentioned there are a number of important fundamental events this week, especially for the EUR/USD. These are the ones I'll be most focused on:

• ECB Trichet speech (Monday 0630 EST)
• Treasury Budget (Monday 1400 EST)
• German and Eurozone ZEW (Tuesday 0500 EST)
• Retail Sales (Tuesday 0830 EST)
• PPI (Tuesday 0830 EST)
• Eurozone CPI (Wednesday 0500 EST)
• US CPI (Wednesday 0830 EST)
• Industrial Production (Wednesday 0915 EST)
• Crude Inventories (Wednesday 1030 EST)
• FOMC Meeting Minutes (Wednesday 1400 EST)
• Initial Claims (Thursday 0830 EST)
• TIC Flows (Thursday 0900 EST)
• Housing Starts and Building Permits (Friday 0830 EST)
  

The economic calendar isn't exactly jam-packed this week but the retail sales data and especially the inflation data will come into close view by market participants. The markets are looking for any signs of life of the US consumer because it is the US consumer which is the benchmark of all consumers around the world. The saving's rate of the US consumer has clearly moved inversely to the overall retail sales figures released so far in 2009 and I do not expect to see a whole lot of change in that trend.

Inflation--  

In terms of inflation, I still firmly believe deflation is a much bigger issue at the present. Do not confuse true inflation, which is simply the printing of money, with price inflation. Some recent data suggests the Fed may actually be printing less money than what was prior assumed. Of course we will never get true and accurate numbers out of the Fed in terms of money-supply, the monetary base and the velocity of money but it could be true to a degree because we are not seeing any signs of price inflation pressures.

Consumers are still in command and are still forcing producers, manufacturers, and retailers to lower their prices. The collective buying power of the consumer base has maintained an overall trend of devaluation and lower price adjustments. In addition, the continued trend of credit destruction, debt repayments, higher savings, moderate commodity prices, falling home values, and rising unemployment are all acting as very deflationary contributing factors. Anybody screaming "hyperinflation" is living outside the realm of reality right now, it's just not there. Equities will want to see higher CPI and PPI figures. Commodity bulls will need to see rising prices as will the higher-risk, higher-yielding currencies. Should the trend of deflation show signs of a continuation it could be a rough week for those markets.

Treasury budget and the USD--

On Monday afternoon the Treasury will release the latest federal budget figures and this fundamental event could certainly impact the Forex and equity markets. Last month we got May's year-over-year budget numbers and it showed a mega spike in the deficit and spending. The Treasury is getting less tax revenue and obviously spending more money. In May 2008 the deficit stood at $165.9 billion and in May of 2009 it was $189.7 billion.

Spending has far outpaced that which the government is generating in revenue. Plus, with all the debt the Treasury is selling combined with the contraction of GDP, the ratio of debt repayments could get very uncomfortable as tax revenues continue to fall, savings continue to rise, and credit expansion stagnates. If the June figures show another surge in the deficit the market may respond by selling the dollar... keep your eye on this data.

FOMC--

The release of the meeting minutes from the last FOMC will be watched and reacted to by all markets. At this point I am not expecting any earth shattering information to be contained within the meeting minutes but you never what kind of surprises might be in there. The Fed has used the element of surprise in the past through the FOMC minutes and should there be any surprising mentions about buying more sovereign debt, raising or lowering interest rates, or on the future of the US economy the markets will move accordingly. 

Risk and price action catalyst -- USD/JPY:

Last Wednesday the Japanese yen made a massive move against the dollar, euro, and pound sterling, gaining several hundred points in a handful of hours. I felt some of the brunt of the move as I had to close net-short yen positions for a loss and while it's never fun to take a loss or to go through the process of recovery, I learned a few valuable trading lessons I want to share.

Market correlations and repeated price patterns play a big role in how I determine entry and exit points on my trades, as most of you probably know. One reason I have grown to love trading the yen crosses is because I have found them to be some of the most pattern-like pairs in the market and I like how they maintain a very close relationship with the S&P 500 and Dow Jones equity indices.

It's no secret the overall strength or weakness of the US equity markets drive currency valuations among the majors and crosses but what I came to learn and understand is that the USD/JPY holds an important place that can act as a driver of the EUR/JPY and GBP/JPY. The Forex market uses the US equity markets to gauge risk appetites and to determine price valuations, and while the EUR/JPY is the pair most correlated to the S&P 500, from my perspective what I see is that the USD/JPY can be the pair most correlated to the overall equity markets, as a whole. 

Price action impact ratios--

In the past I paid little attention to the price action and price pattern behavior of the USD/JPY but now I see that the overall strength/weakness of the USD/JPY directly impacts that of the EUR/JPY and GBP/JPY. Even more importantly, the impact ratio of an extended move on the USD/JPY is magnified anywhere from two to three times on the EUR/JPY and GBP/JPY. In other words, a 200-point extended move on the dollar-yen can translate into a 500 to 600-point extended move on a pair like the GBP/JPY and a 400-point extended move on the EUR/JPY.  

This becomes especially true if those respective yen crosses have spent a greater period of time either moving or ranging to upside or downside price levels. For example, the last time the EUR/JPY spent time at or below the 130.00 level was almost 2-months ago (18-May) and in these last 2-months the EUR/JPY has moved or ranged at elevated levels, going as high as the 138.60 level during the first week of June.

The last time the GBP/JPY spent any time below the 147.00 level was just three days after the EUR/JPY bottomed out below the 130.00 level. Back on 21-May the GBP/JPY reached a bottom just below 147.00 and over the course of the proceeding few months it moved to a high over 162.50. So in this case we see both the GBP/JPY and EUR/JPY spent an elevated period of time gaining and moving to the upside which correlates perfectly to how the S&P 500 and Dow Jones gained during that exact same time frame.        

Stop loss factors--

What helped fuel the type of moves we saw last Wednesday on the yen crosses is squarely on stop losses and stop loss triggering. The relationship between stop loss triggering, price action, and price behavior is very clear and the basis of this relationship goes back to the length of time a currency pair spends at either an appreciated or depreciated level.

Take the GBP/JPY for example... between 21-May and 12-June it moved a staggering 1,500-points+ to the upside. Although the GBP/JPY moved off it's best upside levels, it still maintained upside gains of over 1,000-points all the way until 3-July. What that means is the market was given a very reasonable amount of time to set stops on untold dozens of key psychological and technical levels at least all the way down to the price level where the market first turned up back on 21-May.

On 21-May the GBP/JPY bottomed and turned up at the 146.84 level and guess where it moved to last Wednesday? Exactly 10-points below the original upturn level... it hit 146.74, stopped and bounced back. That is no random fluke of the markets at all but shows how the extended downside move was very much fueled by stops being triggered. When stops are triggered and stop loss orders are hit, that process exacerbates a move to a large degree.

From a price pattern standpoint it also shows there is currently some fairly strong support around the 146.70-80 price zone. If you go back and look at the price action and price patterns of the EUR/JPY you would see almost a mirror image of the GBP/JPY in terms of its upside extension and then it's rapid fall back to old support price levels.

Hopefully this makes sense. At least for me it was a good exercise to go through as a refresher on the core principles of what makes these markets move, why they move, and how we can better capitalize on the markets.  

Correlation between premium, price, and risk:

For years I have been writing about the markets, about the relationship that exists between currencies, equities, commodities, and bonds and while that's all well and good, in the end, no matter how you slice it, price is king and price is all that matters. It's easy to lose sight of price sometimes but price always has the final say so in these markets. When it comes to price, price always carries a premium. There may be many factors used to determine price and valuations but when you boil it all down, it is the premium that the market puts on price which is the ultimate determining factor.

Think about it this way... when the market puts a higher premium on risk it means the market must pay more to get more. The correlation between premiums, risk, and yield (rate of return) is simple -- to get a higher yield or a better rate of return it is going to cost you more money because there is a premium placed on the price and in turn the level of risk changes.

The higher the yield, the higher the risk, and the higher the premium that must be paid to potentially profit. Conversely, when the market determines there is too much risk and the price that must be paid to take on risk has achieved its maximum potential, the premium then gets put on the markets or asset classes which cater to anti-risk, like the dollar or US Treasuries.

Many traders ask me how in the world it's possible for the euro and pound sterling to have such a close positive correlation to equities and for the dollar and yen to maintain a close inverse correlation. In my opinion the correlation is largely determined by the premiums placed on the risk and rate of return.

If the market is willingly taking on more risk and is showing a higher risk appetite the premium on risk goes up and a higher premium translates into a higher price. The euro, for example, yields more than the dollar but in times or seasons of risk aversion, no matter how long those seasons last for, the dollar is considered "safer" than the euro, so the premium and price of the dollar rises against the euro. A season of risk aversion in the equity markets will translate into a higher premium paid on mitigating risk and this higher premium is put on the dollar and yen, therefore it will cost more to own the dollar and yen because the premium has been upped by the market.   

These are very fundamental and psychological aspects of the market and have nothing to do with the technical side of things. It did not matter to the market that S&P 500 and Dow Jones broke above key technical levels, they both have sold-off ever since those technical events took place in the market. Why the S&P 500 failed at the 950 level was because the market said the premium to take on risk to gain a better rate of return at that price level was too high, plain and simple.

The premium to own the S&P 500 at the 950 price level was beyond what the market could bear so the premium got completely flipped... the premium was then placed on the best price in which to sell the S&P 500. Sell high, buy low, right? We all know that saying but what it really relates to is the premium placed on the price of ownership. At some point in the future the premium to sell the S&P 500 will reach an unsustainable level and then it will flip again causing the premium placed on the price to buy the S&P to go up.

When the market sees a higher premium to own a better yielding but riskier asset class like equities, the way the correlation works between equities and currencies will then cause a higher price premium to be placed on the EUR, GBP, AUD, CAD, NZD, etc. That's basically how it all works and how those correlations operate. I like to watch the correlations in price and premiums move in real-time, that is what suits me best, but unless we have a major correlation shift I think it is safe to expect to see those old tried and true correlations move just as they are supposed to.

Trading:

With the lack of any established market trends or clear biases, the price action will be determined by however the markets are feeling at any given point in time this week. This obviously will not make trading an easy endeavor over the next five days, so I would encourage all traders to keep up with the real-time price action of crude oil, the S&P 500 and Dow in relation to how your favorite currency pairs are moving.

And as I mentioned above, price will be king, so no matter how erratic the price action gets, the markets will always overshoot their bounds of price sustainability, they will always over extend and exhaust themselves to the upside and downside, and using those indicators is really where the safest money is to be made.

That's all I have for now. I will be in heavier trading mode this week and spending as much time and energy as possible focusing on the markets, so as time allows I will update the blog. I wish you a great and successful week of trading.

-David

Once again the the markets suffered through another bout of relentless selling and risk aversion. Today the selling began before NY opened and intensified during the Wall St. session. Crude maintained its role as the leading 'fear trade' and the market which took equities and several of the higher-risk, higher-yielding currencies to fresh weekly lows.

In the earlier European session a stronger than expected German Factory Orders report sent both crude and the EUR/USD to their day highs... the EUR/USD spiked up to the 1.4050 level while spot crude simultaneously made an attempt at the $65 level. Both moves, however, were unsustainable. After the EUR/USD took out stops on its spike up and crude came under selling pressure, both correlated markets began falling in tandem.

The S&P 500 futures and Dow futures made their daily highs the same moment spot crude and the euro were making their highs and then they all came tumbling down together, just as their correlation dictates. Basically, market participants couldn't find any real reasons to buy, so they sold. There were no US fundamentals to get euphoric over, no central bankers out talking the markets up, participants had zero to work with and nothing to switch the emotional sentiment out of the fear trade.

This afternoon's 3-year Treasury note auction wasn't spectacular, the yield was a little high and Wall St. didn't like that too much. The stories and threats of market regulation certainly didn't help matters or bring any confidence back into the markets. A few weeks ago market participants were under the impression that the UK economy was in recovery mode but this morning's UK fundamentals told a different story, both data sets printed much worse than expected and negative. It was another rough day for the bulls and probably gave the bears even more confidence to continue the markets in this direction until some news, fundamentals, central bankers or geo-politics changes the sentiment. 

Sign of the times and market psychology:

On 11-July 2008 crude oil began its fall from glory and took all the markets down with it over the course of the proceeding 8-months. Crude got the ball rolling last summer and once again we see history in the process of repeating itself, to a slightly lesser degree. Crude's latest run peaked on 30-June above the $73 level and since then has done nothing but sell-off, dragging equities and commodities with it and boosting the dollar and yen as a result. How much of last summer's history is going to repeat itself? I can't say or predict, but I can clearly see desperation in these markets and the sign of desperation can mean things may get a little ugly and nasty in the near-term. But, it will not last forever... 

Last summer as crude began to crack, the famous crude bull, T. Boone Pickens, went to great lengths to talk it up to protect his multi-billion dollar oil hedge fund. Last summer he was making claims about crude going to $300 and once again this summer he's out trying to talk crude up, saying it will return to $147. His attempts to stop the slide are purely out of desperation, it's obvious. Even the US energy department is trying to talk crude back up, saying crude will make gains toward the $100 level due to increased demand.

What can us traders take away from all this and from what we are seeing play out in the markets right now? First of all, because we know history repeats itself, prepare to see history repeat itself to one degree or another... the other thing is to look for continuing signs of desperation in the markets. Fear and desperation go hand-in-hand and as those two emotions work together to control the trading decisions of market participants, it usually means prices decline which translates into the type of selling we've seen over the past few weeks.

Now, there is a point where the fear and desperation reaches an unsustainable level, leading to reversals in price valuation and market direction. One of the best ways traders can spot that type of turning point is when everybody is saying its the end of the world, it's all over, and conditions have reached the point of no return. When it comes to markets and trading, the majority and the masses are always wrong, especially in the Forex market.

There is only one trend in the markets right now and that trend is emotion. The markets are running on pure emotion and history also tells us that when the masses are running on emotion, they ultimately make the wrong trading decisions. Their emotions act like some kind of weird mind control force that compels the masses to repeatedly pile into the last 5% of an overall market move. Just like when the S&P 500 and Dow broke the supposedly magical 200-day moving average the masses were screaming buy, buy, buy but the market went bye, bye, bye from that moment and hasn't stopped to look back.

As much as I loathe financial entertainment networks like CNBC and Bloomberg I have learned to use them as a resource to find out what the prevailing mindset is, what the emotional state of the markets are, and when the emotions of either fear or greed are reaching their climax so I know when it's most advantageous to do the opposite of the masses.

The S&P 500, Dow, and crude oil may continue in a season of selling and depreciated price valuations and obviously this would mean the US dollar and Japanese yen continue to gain ground on the majors and crosses, but I'm fairly confident in saying that when I see the majority of market participants and the masses join the bear side, I will know that the dumbest of the dumb money has piled into the last 5% of the market's move and hopefully I'll have the insight to know to run the opposite direction.

The masses totally got it wrong when they pushed the Dow Jones and S&P 500 to their all-time historical highs in the midst of the worst credit crisis and economic depression since the 1930's. The credit crisis began exactly on Sunday, August 12, 2007 and the US recession was in full bloom by December 2007, yet the equity, commodity, and Forex markets continue rising at an unprecedented pace. The US housing market was in full meltdown mode back in March of 2007 but the masses were still trying to flip homes, buying investment properties, and were taking out second and third mortgages.

It basically took a year for the masses to totally pile into the wrong side of every tradeable market on earth before the market itself ran the opposite direction and reversed on them.  Traders can absolutely profit from playing along with the emotionally-driven masses, there's nothing wrong with that but don't lose sight of the very tried and true principle of all tradeable markets -- the longer things stay the same, the more they need to change.

Wednesday trading:

The main themes for tomorrow will focus squarely on fundamentals, central banks, and geo-politics. The G8 will become the center of the universe as their 3-day meetings kick off in Italy. They should really change the name of the G-8 to the G-80 because everybody and their brother will be there but what we need to be on the lookout for is any pro or anti dollar rhetoric out of the BRIC nations and of course from the Fed, ECB, BOE, and BOJ. China, Russia, and Brazil are the three wild cards because they hold the power and potential to push the dollar around the rest of this week.

Both the dollar and yen have benefited positively from the sell-off on Wall St. and the plunge in crude prices but I still have no overall confidence in either currency due to their abysmal fundamental situation and the fact I believe the Fed will have to keep printing money to rescue the economy. We will hear growing talk of congress coming up with a new multi-billion dollar economic stimulus plan as the US fundamentals and weakness on Wall St. persists and that may turn some negative focus back onto the dollar.

Beside the G8 event, the markets will contend with Eurozone GDP and German Industrial Production data. Out of the UK there is an inflation report and then later in the NY session we get Crude Oil Inventories which should cause a nice dose of volatility with crude being under the microscope right now.

The most important job for traders the next three days is to be diligent to keep up with all the verbal rhetoric and verbal manipulation that comes out of the G8. If the central bankers and finance ministers want to talk the markets up or down, they will use the G8 event as their opportunity to do so. Don't let them catch you off guard because they love to use the element of surprise to move the markets. The trading conditions will be risky tomorrow as Wednesday's have been following a trend as the most volatile trade day of the week, so manage your risk accordingly.

-David   

When I sat down to write my commentary on this week's trading all I could think was, "this should be a wild week". What's facing the markets are a number of calendar events and central bank events that are all culminating over the next five trading days, so the key theme I want traders to keep in the forefront of their minds and trading decisions -- risk management.

High risk alert--

Over the next 48-hours the price action of the Forex market, equities, commodities, and fixed income will all be under the direct influence of a major calendar event that I like to refer to as "end of quarter book squaring". Monday and Tuesday are the final two trade days of Q2 and that will be the very last opportunity for market participants like hedge funds, money managers, brokers, institutional traders, and participants in banking/finance to show some kind of a profit or to mitigate an unrealized loss. 

Historical price action patterns and historical price behaviors show a repeated pattern of heightened volatility and extended periods of strong price swings the final 48-hours of each quarter. This is not a random coincidence but due to the process for how market participants close out positions, for profit or loss. The end of quarter price swings also repeatedly reoccur due to the continuous and varying degrees of money-flows and levels of liquidity that are moving in and out of all the financial markets as participants are squaring up, repositioning, or pre-positioning.

The strong correlation between currencies, crude oil, gold, the S&P 500, Dow Jones, and Treasuries dictates the high probability for intensified price action across the board as each of those individual markets affect each other as a whole. At least for the next 48-hours forget the charts, forget the multi-colored dissecting lines, all that junk is meaningless because the markets will be driven by fear and greed... just follow the money trail...

The end of quarter window dressing that goes on is driven purely by fear and greed -- fear that a money manager or hedge fund won't show a profit for Q2 or greed that a money manager or hedge fund can potentially show a bigger profit than expected in order to pad their fees and commissions. Many market participants are under intense pressure to show a profitable performance in order to make their quarterly statements look good and this means some of those participants will either take profit off the table, be forced to cover an unrealized loss, or to do some revenge trading to make that bonus or commission and to keep the phone calls from angry clients to a minimum.

I love the end of quarter madness because it shows how human emotions really control markets and drive price action. I recommend to most retail Forex traders to sit on the sidelines while the markets go through this process, especially for those traders who are too under capitalized to be in the FX market in the first place.

End of quarter trade plan--

Other than reducing the amount of margin I use for each trade position I won't be doing a whole lot different over the next 48-hours in terms of how I pick my entries and exits. That being said, I am starting the week with an anti-dollar bias until we at least get through the end of quarter book squaring event. In my trading career I've been through ten end of quarter events and based on what my experience shows me and on what historical price action shows, the dollar historically has a higher probability of weakening against the euro.

With the Forex market's tendency to repeat price patterns over and over again, I'm choosing not to fight against history or human behavior. Of course if crude oil, gold, and the S&P 500 make gains over the next 48-hours the dollar should be under downside pressure just from those factors alone.

After we get past this calendar event I may reevaluate my anti-dollar bias because we will be coming up on the 1-year anniversary of the market's monumental meltdown. It was just two weeks into Q3 last year that the Forex, commodities, and equity markets plunged from their historical highs... the EUR/USD, crude oil, and the S&P 500 all made their historical highs in tandem (not a coincidence) and as crude oil was the first to crack and sell-off from the $147 level, the S&P 500 tanked which took the EUR/USD from the 1.6000 level all the way to the 1.2300 level between last July and October.

I'm not predicting or expecting an exact repeat performance of last summer but after we get past this week's calendar events which include an ECB monetary policy meeting and NFP, there's really no way to predict what the markets will decide to do next. History will always repeat itself but at this point I am not seeing the market's sentiment move closer to the side of risk aversion as opposed to where participants have been in terms of maintaining a higher risk appetite.

Keep things as simple as possible, don't fight against the market correlations even if they appear disjointed at times but to just go with the flow, follow the money and when you do not have a clear view on where you think the market will go, sit out and protect your capital. The great Jesse Livermore once said:

"The game of speculation is the most uniformly fascinating game in the world. But it is not a game for the stupid, the mentally lazy, the person of inferior emotional balance, or the get-rich-quick adventurer. They will die poor."

Fundamental events moving markets this week:

The end of month/end of quarter/start of new quarter are not the only calender events that will move markets this week. There are a number of fundamental factors that will come into play as traders attempt to determine the short-term fate of the euro, dollar, pound sterling, and yen. Underlying fundamental factors like inflation, deflation, monetary policy, employment, manufacturing, and the health of the consumer will all come into view by the markets.

The following fundamental factors hold the highest potential to move the EUR/USD and its correlated markets this week:

• Eurozone Consumer Confidence (Monday 0500 EST)
• Eurozone M3 Money Supply (Tuesday 0400 EST)
• Eurozone Flash CPI (Tuesday 0500 EST)
• US Consumer Confidence (Tuesday 1000 EST)
• German Retail Sales (Wednesday 0200 EST)
• ISM Manufacturing and ISM Prices (Wednesday 1000 EST)
  
• Pending Home Sales and Construction Spending (Wednesday 1000 EST)
• Crude Oil Inventories (Wednesday 1030 EST)
• ECB Trichet monetary policy press conference (Thursday 0830 EST)
• Non-Farm Payrolls and Unemployment Rate (Thursday 830 EST)
• Eurozone Retail Sales (Friday 0500 EST)
• US bank holiday (Friday) 

There will also be plenty of central bankers from the Fed, ECB, BOE, BOJ, and SNB speaking this week. The markets are still ripe for market-moving verbal manipulation, do not get caught off guard because the central bankers may want to use the market conditions to their advantage this week to move their respective currencies one direction or the other.

The ECB and monetary policy:

At 0745 EST on Thursday the ECB will release their latest decision on their monetary policy for the key lending rate. At this point I see a no-change in their interest rate policy. The main reason I believe the ECB rate will leave rates at 1.00% is because Trichet has repeatedly said he's not cutting rates this month. Trichet could just be messing with the market's minds but his pattern of behavior in the past shows a much higher tendency for his rhetoric on interest rates to match actual monetary policy.

Remember what the ECB did to the dollar last Tuesday? In case you forget you can re-read it here. It only took a few comments on interest rates from the ECB to send the euro flying against the dollar last week. If Trichet wants to boost the euro again he can do it at his monetary policy press conference on Thursday.

For the past few weeks the Fed and ECB have worked well together to keep the EUR/USD in a relatively tight range. The purpose for this isn't anything I know but it doesn't matter, the evidence is clear based on all the verbal rhetoric and monetary policy actions by both central banks. The latest FOMC monetary policy event did not reveal a strong pro-dollar bias. I think their statement left the door open for market participants to continue selling the dollar when the opportunity presents itself.

The ECB has maintained a fairly consistent pro-euro stance recently. Could this change suddenly? Of course, but for now I'm adding the central bank and monetary policy factors as another reason for my anti-dollar bias because the recent trend between the Fed and ECB has been anti-dollar, pro-euro. Until the central banks change their bias, I'm not changing mine.    

Trichet is pretty reliable when it comes to telling the market what to do with the euro. If Trichet wants the euro to keep gaining on the dollar he will paint a good picture of the Eurozone's economic, fundamental, and banking sectors. If Trichet tells the markets that deflation is not an issue and that ECB interest rates have reached their lowest threshold, that's his way of telling the markets to appreciate the euro and to buy it against the dollar.

If Trichet wants the euro to depreciate he will tell the market's the ECB is concerned about deflation, that interest rates can go lower in the future, that the ECB is going to monetize sovereign debt, that the Eurozone economy is going to contract further than previously expected, and that the European banking system is fractured.

I can't predict which message we will hear from Trichet but it won't be hard to figure out at his press conference. It should not be a mystery, Trichet uses less double-speak than Bernanke and it is very easy to read between the lines to decipher what he wants the market to do with the EUR/USD.

Treasury bonds and the US dollar:

The past couple of months there's been a lot of focus put on Treasuries and the US debt market, and ever since the Fed announced it would buy up to $300 billion worth of debt, the Treasury/Dollar connection has received the full attention of market participants. When I see something on Bloomberg or CNBC about Treasuries and the US dollar I never see the commentator or analyst explain the relationship between the two.

I think it is important for Forex traders to get a grasp on the Treasury/Dollar connection because their relationship affects both the debt and currency markets in very specific ways. The currency market is not a single entity unto itself and one of the correlated markets which helps determine currency valuations is the US debt market.

Next to the currency market, the US Treasury market is the most liquid in the world. This means the Treasury market can easily handle multi-billion dollar transactions, they can absorb selling pressures while preventing wild price swings, Treasuries are easily converted and there has never been a default on US debt, to date. US Treasuries are considered to be the safest and least riskiest asset class used for investment purposes.

One of the big reasons Treasuries have a strong affect on not just the Forex markets but all financial markets is because they are made up of the two biggest components that drive risk appetites -- price and yield (rate of return). All tradeable financial market are just a space for speculators to seek a rate of return on their money. Some speculators want to get that rate of return as safely as possible while others want that astronomical rate of return. But the way it works is, the lower the risk, the lower the yield, the higher the risk, the higher the yield.

In order for market participants to trade in the US Treasury market they need to use the US dollar and in order for the Treasury to meet its obligation to its creditors they need to use the US dollar. The use of the dollar comes full circle from the moment the investor hands the US government his money for a predetermined amount of time back to the moment when the federal government pays their creditor interest and then principle when the debt obligation comes to full maturity. That factor alone is just enough to affect the dollar's valuations against currencies like the euro, pound sterling, Swiss franc, and yen.

The other key factor which causes the valuation of the dollar to change is also directly related to the yield of each respective US debt obligation. Earlier this year the 10-year note was yielding just 6bps above the 2.00% level and now the 10-year is yielding over the 3.60% level. That means the US government is getting a lower price for their debt and that it will cost the government more money to pay its debts. Right now the US government has a major deficit problem, public debt has skyrocketed and those factors are bad for the US dollar and are a strike against it.

Then when the Treasury prints money to give to the Fed to return it back to the Treasury in exchange for its own debt, the dollar gets a really big strike against it. In a normal world this process of monetizing sovereign debt would be impossible but when you have the Fed and Treasury working so closely together with powers that are not even constitutional, they are like the Super Friends of the financial markets, they can just do whatever they want and nobody can stop them.

All Treasuries have a minimum denomination of $1000 and there will always be more supply than demand and that's another reason the Treasury market is so liquid and how multi-billions of dollars can move in and out of the market on a daily basis. This factor also has a direct affect on the valuation of the US dollar at any given moment of the trade day.       

The other factor with the connection between Treasuries and the dollar is debt repayments... lets suppose you bought a $1000 debt obligation on the 10-year note at a yield of 4.00%. That means the government would pay you $20 every 6-months and then at the date of maturity they would return your $1000 in principle. The more debt that is supplied and purchased means the government has more debt to pay back which is bad for the dollar. Plus, the more debt that is supplied means the yield is higher and the government has to pay more to get less.

Dollars have to be printed to facilitate these processes and of course that is a big strike against the dollar. A market situation where Treasury yields are rising can be dollar positive but the cause for the higher yields is the key. If Treasury yields are rising because the Treasury is over supplying the market with debt, that is bad for Treasuries and bad for the dollar. Printing money is the purest form of inflation and when inflation rises the value of Treasuries falls.

Foreign debt holders like the Chinese see their investment in Treasuries erode when the value of their investment falls and the dollar weakens. Whenever inflationary price pressures pick up again in the future any foreign investment in Treasuries will devalue accordingly. Add the combination of inflationary price pressures and a depreciated US dollar and US debt looks pretty unattractive. 

I don't want to over complicate this stuff but hopefully this sheds some light on why the Treasury market is so closely correlated to the Forex market and why movements in the Treasury market lead to movements on pairs like the EUR/USD, USD/CHF, GPB/USD, and USD/JPY. Even though I'm purely a currency trader I keep close tabs on the Treasury market because I think bond traders are very smart and well adjusted to the fundamental, monetary policy, and geo-political factors which move the markets.

Swiss National Bank interventions:

Between March and as recent as last week, the SNB has gone on a quest to manipulate and devalue the Swiss franc. In the past three months there's been at least six open-market operations by the SNB and BIS to depreciate the franc versus the euro. The secondary affect of their open-market operations results in the dollar gaining against the franc and because the USD/CHF and EUR/USD maintain mostly an inverse correlation, the EUR/USD routinely moves lower during these interventions just for the fact the USD/CHF and EUR/CHF move higher.

Why the SNB is depreciating the franc--

The SNB and BIS are most concerned with the valuation of the EUR/CHF and their main objective is to sharply weaken the franc against the euro. The SNB's motivation to devalue their own currency is about as simple as it gets... debt holders in Europe, especially in Eastern Europe owe Swiss banks money and they want to get paid, bottomline. The Swiss are good financiers and so they are using monetary policy to make it easier for European debtors to pay their Swiss creditors. The secondary factor is to help support the Swiss exporting industry. 

The SNB dumps francs and buys euros right on the open market and that's why those 150-point spikes occur on pairs like the EUR/CHF and USD/CHF. I do not trade either of those pairs but if I did I would be watching the SNB and BIS like a hawk and I'd never attempt to trade against them. Traders who are purely technical and who do not pay attention to the central banks have been steamrolled by these interventions and those traders who understand how the central banks affect the Forex market have been on the right side of these moves.

I personally think the interventions can continue in the near-term until the SNB has achieved its objectives. As long as Eastern Europe remains on the brink, the Swiss will likely see to it the CHF remains depreciated against the EUR. Do not fight the SNB on this stuff, it's not worth it. Central banks love using the element of surprise to hit the markets when they least expect it and this week could easily present more opportunities to see a repeat performance.

Correlated markets:

Beside all the monetary policy, fundamental and calendar events that will be moving the markets we need to keep up with the price action of crude oil, gold, the S&P 500, Dow, and Treasuries. If the higher-risk, higher-yielding correlated markets make upside moves the dollar and USD Index will come under renewed selling pressure this week. Beside all the underlying fundamental factors, crude and gold will be the two linchpins which can make or break the markets and I will be watching both closely and using both as trade indicators.

Support and resistance levels--

In preparing for the trade week I spent some time studying the most recent price action and price behavior patterns of the markets and these are some of the overall key price levels on the upside and downside I'll be monitoring...

Spot crude -- the market has shown a pattern of buying crude when it dips below both the $69 and $67 levels. Below there is more support sitting around the $65 level. I'm not expecting any big downside moves with crude this week unless there are heavy rounds of profit-taking or geo-political factors that might come into play. On the upside strong resistance is seen just above the $73 level with minor resistance seen around the $72/$71 level.

Spot gold -- gold spent most of the month of June in a downward directional move but the same exact day the six ECB's came out to talk the euro up against the dollar, spot gold hit a bottom and has since moved up decisively (not a coincidence). Currently there is some resistance between the $943 and $945 levels while support is sitting at the $923 and $913 levels. Strong resistance for spot gold sits around $988 while strong support is currently around $888. A strong move up in gold this week should carry the euro and pound sterling up with it.

S&P 500 futures -- this correlated market has had a wild ride in recent weeks... the S&P 500 futures made three solid attempts to sustain a break of the 952 level on the topside and failed. On the downside, the market made several runs at the 888 level but also failed to break below there. Near-term support is sitting around 901-900 while near-term resistance is around the 920-925 levels. If the S&P 500 puts in a strong showing it should carry the higher-yielding currencies right along with it or vice versa.

EUR/USD -- price action patterns show the first line of support is strong at the 1.3982 level and then at the 1.3828 level, and then further strong support sits at the 1.3753 level. On the upside, there will be some resistance around 1.4088, then at 1.4178, and then at the 1.4226 and 1.4340 levels. Any of these upside/downside levels can easily be broken this week and the probability remains high for a EUR/USD range break in the days ahead, especially with all the fundamental, monetary policy, and geo-political events going down.    

That should about cover things for the week ahead. Like I said at the start, good risk management should be at the forefront of your trading decisions at least over the next 48-hours and especially on Thursday. If you find yourself on the wrong side of the market it's always easier to recover from a small loss than it is to make up when you let a position run away from you.

Finally one last quote from Jesse Livermore:

"All through time, people have basically acted the same way in the market as a result of greed, fear, ignorance, and hope. This is why the numerical formations and patterns recur on a constant basis."

Courtesy of stronger than expected fundamental and economic data all markets saw a volatile start to the week. Commodities, equities, and energy all surged in today's trading which is a death knell for the battered dollar and yen... the S&P 500 gained 2.6% today and made it's highest close in 7-months, crude oil hit the $68 target I gave in last night's update, while spot gold inched its way even closer to the mega $1K level. Let's take a closer look at what moved the markets today...

Global manufacturing fundamentals lead market rally, send dollar and yen plunging:

Upside surprises on manufacturing data was the main story of the day and the fundamental factor that drove all higher-risk, higher-yielding markets to rally, leading to sharp losses for the USD and JPY. The upside surprises in the manufacturing sector began Sunday evening as the latest PMI data out of China, which has been moving higher the past 3-months, showed sustainable signs of growth instead of contraction.

Within minutes of the Chinese manufacturing fundamentals hitting the wires market participants began buying equities, commodities, and higher-yielding currencies like the GBP, EUR, and AUD. Further downside pressure was put on the dollar and yen after UK PMI printed at a 1-year high while Eurozone PMI showed its best improvement in 7-months. The UK PMI data was especially beneficial to lead the GBP/USD and GBP/JPY to substantial gains. Later on in the morning JP Morgan's Global PMI indicator jumped to 45.1 after printing 41.8 in April and was the biggest gain in 9-months

And finally we got US manufacturing data from ISM. Not only did ISM Manufacturing and ISM Prices show headline prints that beat market expectations, the individual components that make up these reports were very hot. In my breakdown of the data I saw that the ISM New Orders component printed at their highest since November 2007, showing a month-over-month gain of almost 4%. The Prices Paid component moved to its highest levels since September 2008, gaining 11.5% month-over-month.

With data like that, especially on the prices components within the PMI data, the markets couldn't do anything but go up. From China, to the UK, to the Eurozone, and then to the US, all of the manufacturing fundamentals were off-the-charts good and all printed with an upside surprise. This was definitely not one of those days for traders who attempted to trade against the fundamentals. But, in my view, although the fundamentals were the main driving force there was a little more to the story than just good data...

Price action beyond fundamental factors:

In today's trading we saw some extreme moves on pairs like the GBP/JPY, EUR/JPY, USD/JPY, and GBP/USD. Clearly there was a pure fundamental basis for each of those pairs to move in the direction they did but not exactly to the vast degrees in which each pair moved respectively. While all fundamental and market correlation factors were strongly against the USD and JPY, after analyzing the price action from today and the pattern of the 30-minute opens on those pairs, I believe today was a case where the fundamentals had some help to drive prices.

Now obviously the S&P 500, crude oil, Dow Jones, spot gold, and US Treasuries were all working in unison to push the USD and JPY lower but I think from a pure price action perspective and what I know about price movements of the majors and crosses, I feel the factor of stop loss triggering and margin-calling played a big role in addition to the fundamentals. I do not have any raw data from the brokers and this is just my own opinion but I give the factors of stop loss triggering, position liquidation (short covering), and margin-calling as much as a 30% weighting towards today's price action on those pairs I listed above.

From a pure price action perspective, what is a fact is that stop loss triggering and widespread margin-calling both act as catapults to propel price further in the direction in which price is liquidating positions. On the retail FX side of things most brokers will take the opposite side of their customers trade and while retail FX traders and brokers do not exactly have the power and liquidity to move the market, the massive stop loss triggering and margin-calling from the combination of retail, commercial, and institutional players absolutely works to propel price and move price against those large and small positions.

There's a reason why the EUR/USD did not move up to the degree it's counterparts moved and I believe this is because far fewer traders were net short on the EUR/USD as opposed to those attempting to short the pound sterling and yen crosses in today's trading. The EUR/USD dropped resoundingly in the late afternoon NY trading because a higher percentage of traders were likely net long on the euro at or above the 1.4150 and 1.4200 level and the exact type of price action effect took place on the EUR/USD as it did with the GBP/USD, GBP/JPY, and USD/JPY, just in the opposite direction.

Many traders will monitor volume as an indicator and while I'm not a big proponent of volume in FX trading because there is no central exchange for spot Forex, for traders who see low volume levels on a strong upsurge or low volume levels on a strong downsurge, this is a fairly cut and dry indication that the stop loss triggering, margin-calling and position liquidation is likely one of the leading factors catapulting price when there is little to no buying/selling conviction behind the move. The other leading factor would be all those traders who think they missed a move and pile into the last 5% of an up or down move and then the market reverses on them.

It's not exactly a common occurrence to see a day where the GBP/JPY moves over 570-points bottom to top from Sunday's open until NY's close or for the GBP/USD to move almost 400-pips bottom to top during the same time frame and I absolutely believe those price surges were fueled by the price action effect of stops being triggered and positions and accounts being liquidated which is a very natural characteristic when price action is propelled to such extremes.

When a good currency is bad:

Over the past few days I've been getting questions by traders about the appreciating euro and how it could be a good thing. That's a very good question and as the euro and pound sterling have rapidly appreciated against the dollar and yen in recent months I think it's important to keep a few aspects of currency appreciation in perspective. With any upside for a currency there's always a downside. For this commentary I'm going to specifically focus on the euro, but it works much the same with any currency. 

1. Buying power vs. earning power

Very simply, a strong euro gives foreign importers less buying power and it leaves Eurozone exporters with less earning power. Germany is the Eurozone's biggest exporter and one of the top exporting nations on the planet. When the euro is strong, especially against the dollar, German exporters suffer from less profit and less global trading opportunities because the euro's value is too lopsided. For example, it would cost a US importer of German goods more US dollars to purchase and import those goods and this acts as a deterrent to trade. In order to attract more trade and more exporting opportunities, Germany and other EMU companies generally have to drop their prices or else they sell less product.

Eurozone exporters should be very concerned about the rapidly appreciating euro because of the fact there is still a recession in Europe and every company who imports, especially if they import to turn around to sell retail, will continue to ignore countries where they have less buying power and right now there is less buying power in Europe. US exporters should be jumping for joy by the way the dollar has plunged and I'm sure their comrades in Europe are not too happy with the euro-dollar situation. It will be interesting to see if Trichet talks the euro down on Thursday in order to take some of the pressure off Eurozone exporters...

2. Deflation

A strong currency isn't always deflationary but it is deflationary when it's negatively affecting exactly what we talked about above. When a strong currency forces a company to lower its prices in order to appease an exporter, wholesaler, retailer, or consumer, this is pure deflation. When a market or a consumer steps back and says, "No way, I'm not buying your product until you drop the price" that is deflation at its essence. Deflation exists when the combined power to purchase controls and prohibits the ability to produce goods and bring them to market at sustainable levels and steadily rising prices. Right now I see a strong euro contributing to the deflation that exists in the Eurozone even though the ECB continues to deny it.     

When the consumer is strong the consumer can cancel out the deflationary effects of a strong currency because they already have a pre-programmed inflation expectation, especially when commodity prices are high, and they do not shy away from higher prices for goods and services. Right now there is no consumer and if the appreciated euro causes the consumer to further entrench this will only further exacerbate deflation in the Eurozone. 

Those are two of the biggest downsides I see to a strong euro. Other downsides include making it more difficult for deleveraging Eurozone banks to handle their debts, losses and writedowns. The same is true for UK banks as the pound sterling continues to appreciate. As bearish as I am on the dollar, I'm almost just as bearish on the euro because of these factors and I believe the euro's valuations do not match it's standing against the dollar and how it trades against the dollar through the USD Index. But until the markets are forced or led into another season of risk aversion, it will be hard for the euro to depreciate against the dollar to any large degree. No matter what, I think it is very important for traders to understand some of the negative fundamental aspects surrounding a strong currency because every sovereign nation should want their respective currencies to suffer the same fate as the dollar and yen.

Trichet is quite proud of the strong euro but eventually he may be forced to talk it down to stimulate growth and to help Germany and the rest of the EMU out of its recession. An appreciating currency is very much the equivalent of higher interest rates and higher borrowing costs. Those are good things for market participants seeking higher-yields but very bad things for the overall economy that needs low interest rates and cheap money to re-inflate itself.

Tuesday trading:

On Tuesday we have another big fundamental day. For those traders who got steamrolled by today's fundamentals it would be a good idea to pay close attention tomorrow because we get more manufacturing, growth, housing, jobs, and consumer data out of the UK, Eurozone, and US.

AUD/USD--

At 1230 EST this morning we have an RBA interest rate event and I expect to see the RBA hold rates at 3.00%. A surprise rate cut would obviously be a shock to the markets and should this occur I may look for a great trade opportunity on the AUD/USD. I've been bullish on the AUD/USD going all the way back to the first week of April and it's pretty much done nothing but go up since then. You can read my bullish AUD commentary here if you'd like a refresher.

EUR/USD--

The big event for this pair is the Pending Home Sales data and I expect a better than forecasted print because the data is counting foreclosure sales which may likely skew the data to the upside. In order to rattle Wall St. we would probably need a bigger downside shock with the housing data but I am not expecting to see this. The only important data out of Europe is the Eurozone Unemployment Rate which I forecast to print at 9.0% or higher.

GBP--

At 0430 EST there is key fundamental data out of the UK with Construction PMI, consumer credit, and mortgage approvals. If the UK data prints as expected or better, which has been the recent trend, be on the look out for another upside surge on the pound sterling. Market participants are looking for any piece of news or data to keep pushing it higher and they may get some more tomorrow.

As far as trading goes, my bias remains clear, intact, and exactly as it's been for over a month -- I'm anti-dollar, anti-yen and I see no fundamental basis to buy either of those currencies against the majors or crosses until fundamental and market sentiment factors change. Very simple. Fundamentals are driving market participants and their money-flows and it will take an event, situation, or geo-political surprise in order to cause risk aversion which would benefit the dollar and yen. Until that happens or until crude oil and the S&P 500 move lower, the dollar and yen will continue to devalue and suffer.

Please be smart with your risk and money management, do not overleverage under these volatile conditions. EUR/USD key levels will be posted in the morning before Wall St. opens.

-David

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

Typically on Sunday's I do a weekly market outlook, but there's so much happening this week in Forex, equities, commodities, Treasuries, and on the geo-political front, I don't have the time and space to fit everything in. So, for this update I'm going to get us ready for Sunday/Monday trading in addition to hitting some core underlying fundamental factors I feel are imperative we traders need to be mindful of and thinking about as we get ready for what's shaping up to be a challenging summer session.

S&P 500 versus the US dollar index -- Battle of the gods:

In my view, out of all tradeable markets that exist on earth like Forex, stocks, bonds, and  commodities, there are just two giants... there are just two 'gods' of the markets, just two leading benchmarks, just two pinnacles of the entire global financial system... those two titans of all tradeable markets are the S&P 500 and the US dollar Index.

Those two 'gods' of the markets are always temperamental, caustic, sometimes unpredictable, and will unleash their fury when least expected, utilizing the element of surprise. As mighty as these two supreme beings sound, it is the war they wage with each other where us lowly traders can capitalize on the acrimonious relationship that exists between the S&P 500 and the US dollar Index.

For over two years I've been teaching traders how to use the correlation between the S&P 500 and the EUR/USD to trade and make money. I'm not going to take the time to rehash that now, but what we're going to do is take a broader and more historical view on the S&P 500/USD Index correlation in order to gauge what the future possibly holds for the markets, specifically the currency market, and even more specifically, the EUR/USD, EUR/JPY, and GBP/JPY.

Comparison between historical bull and bear markets with the S&P 500 and USD Index--

As most of you know, my personal philosophy on trading says that because the emotions of fear and greed cause humans to control the prices of all tradeable markets, price action patterns are repeated over and over again, and prices go in a circle, not up and down. So, my goal in taking the historical price action patterns of the S&P 500 and USD Index is to help validate my theories on how the relationship of human-controlled price action leads to specific patterns of behavior within the two 'gods' of the markets, and in turn, how these two supreme beings act as some of the most core underlying fundamental catalysts that drive price action and market trends. The other core underlying fundamentals, of course, are interest rates and geo-political events.

Note: for those of you who are new, just a quick reminder, my theory and philosophy on trading says that a strong inverse correlation exists between the S&P 500 and US dollar, and they they are constantly at battle with each other... in general, when one is up, the other has to be down. 

For the purpose of this exercise, I'm going back to just before the Bretton-Woods II era. If you're unfamiliar with that event go back and do your homework, especially if you want to make money trading FX. What I'm going to do here is simply take each historical bull market for the S&P 500 and each historical bear market for the USD Index and compare the two to reveal what kind of correlation exists after the USD Index was established and the US dollar became the world's reserve currency.

S&P 500 bull markets:

10/7/1966 to 11/29/1968. Lasted 748 days. Percentage change: 48.05%
5/26/1970 to 1/11/1973. Lasted 961 days. Percentage change: 73.53%

USD Index bear market:

1/31/1967 to 7/6/1973. Lasted 2,348 days. Percentage change: -24.48%

Between the two bull markets in the S&P 500 between 1966 and 1973, the USD Index remained in a constant bear market... evidence of a clear inverse relationship between the two titans.          

S&P 500 bull market:

10/3/1974 to 11/28/1980. Lasted 2,248 days. Percentage change: 125.63%

USD Index bear market:

1/23/1974 to 10/30/1978. Lasted 2,348 days. Percentage change: -25.05%

Four out of the six years the S&P 500 rallied, the USD Index remained in a bear market. Then, the USD Index went on a strong bull market run between 10/30/1978 all the way to 2/25/1985, just over 6-years. During this time, between 11/28/1980 and 8/12/1982, the S&P 500 went through a bear market lasting 622 days and losing 27.11%. So, at this point, the evidence continues to strongly favor the inverse correlation between the two.

S&P 500 bull market:

8/12/1982 to 8/25/1987. Lasted 1,839 days. Percentage change: 228.81%

USD Index bear market:

2/25/1985 to 12/31/1987. Lasted 1,039 days. Percentage change: -48.15%

OK, here we can see an interesting correlation... as we talked about above, there was one S&P 500 bear market during the USD Index's sustained rally, but look what happened when the S&P 500 hit another bear market in August 1987... just four months later the USD Index's bear market was over and the USD Index went on a bull market rally from 12/31/1987 to 6/14/1989, gaining 23.74% while the S&P 500 went on another bear market that lost 33%.

S&P 500 bull market:

12/4/1987 to 3/24/2000. Lasted 4,494 days. Percentage change: 582.15%

USD Index bear market:

6/14/1989 to 2/11/1991. Lasted 531 days. Percentage change: -23.83%

Now, between 2/11/1991 and 7/5/2001, the USD Index went on a strong bull run that lasted 3,797 days. During this time, the S&P 500 went through a bear market from 3/24/2000 to 9/21/2001. That S&P 500 bear market lasted 546 days and the interesting fact is, less than two months before the USD Index's bull rally came to an end, the start of the S&P 500's next bull rally began... more signs of the inverse relationship.

S&P 500 bull markets:

9/21/2001 to 1/4/2002. Lasted 105 days. Percentage change: 21.40%
10/9/2002 to 7/19/2007. Lasted 1,744 days. Percentage change: 99.94%

USD Index bear market:

7/5/2001 to 11/7/2007. Lasted 2,316 days. Percentage change: -37.69%

Now the inverse correlation between the two titans becomes clear as day. The last USD Index bear market ended less than 4-months after the S&P 500's historic bull market ended. The USD Index was brutalized between 2001 and 2007, and even into the first 4-months of 2008 while it's inverse correlated markets continued to make strong gains.

Lets think this through a little deeper... what else happened between 2001 and July of 2008? Well, the EUR/USD was put on the tradeable market, making unprecedented gains all from about 0.8600 to 1.6000, spot crude went from about $20 a barrel to $147, The EUR/JPY went from about 99.00 to 169.00, and the GBP/JPY went from about 165.00 to 251.00.

The future of equities and the dollar--

As the S&P 500 went on a mega bull run it brought the euro, pound sterling, and spot crude with it while sending the dollar and yen to their depths, as evidenced by the 6-year+ bear market on the USD Index. So, what does this all mean for the future of the S&P 500 and the US dollar? If my theory holds true, the S&P 500 will need the USD Index to go lower and bearish in order to rally. Historical price patterns shows that both 'gods' of all tradeable markets cannot achieve supremacy simultaneously, they both can't sit on the throne, one will have to yield power to the other.        

If you're a chart-type person, go back and look at how the USD Index has performed since the S&P 500 began its rally on 10-March, you'll see exactly what I'm talking about. Again, in my view, these are some of the deepest core underlying fundamentals of all tradeable markets. We took a very broad view at this inverse correlation, but when it comes to day-to-day trading, I distill it all down on a 30-minute basis and simply trade according to the correlations of these underlying fundamentals.

If you want a good look into the future, forget the lagging indicators and keep an eye on whose winning the battle between the S&P 500 and the USD Index because it's a beautiful leading correlation and about as simple as it gets.

Stress test results delay = bad sign for Wall St. financials:

Is good news ever delayed? I don't think so, nobody delays good news... after delay upon delay, the markets were told and prepared for the results of the banking stress test on 4-May. Now we're being told the results likely won't be released until 7-May at the earliest, possibly even later.

The Fed is either buying more time to perfect a smoke and mirrors act for when the results hit the markets or they are preparing yet another bail-out package because the regulators will reveal what we already know -- the US banking system continues to carry systemic risk of insolvency despite every liquidity and credit scheme enacted by the Fed since March of 2008. There are only 19 banks and financial institutions going through the stress test but those 19 institutions hold roughly 66% of all assets and 52% of all loans in the entire US banking system. Most of the banks being tested, if not all, will need to raise capital and that goes right back to the risk of insolvency.

Look at what Goldman Sachs did just one day before the preliminary results of the test were due to be released back on 1-May... Goldman, the so-called "best and the brightest" on Wall St. made new issuance of bonds and stocks to raise capital. Goldman sold $2 billion worth of 5-year notes and $750 million in a new stock offering, all without government backing. It doesn't take a genius to read between the lines here... Goldman clearly wants to avoid being targeted by banking regulators and they want to pass the stress test with flying colors, so they went ahead and raised their capital prior to the test being completed and the results being revealed.

Last Friday three more US banks failed, bringing the total failures in 2009 to 32 banks. Just from those three bank failures on Friday it cost the FDIC $1.4 billion. Here again we see clear evidence the risk to the entire US banking system goes well beyond the 19 banks undergoing the stress test. I think nationalization is the worst-case scenario result of the stress test, and Wall St., specifically the S&P 500 financials index, will not be happy about one or more of the 19 banks being taken into receivership by the government.

Fundamentals and geo-politics:

This week is going to keep market participant's heads spinning because of the strong mix of key fundamental events and the high level of geo-politics. In addition to the glut of inflation, housing, consumer, manufacturing, and production data on the books this week, there are several monumental interest rate events, plus NFP, plus speeches by various Fed and ECB members, and of course the growing concerns over a potential flu pandemic.

The following list are the fundamental and geo-politcal events I feel are most important this week for the EUR/USD:

• German Retail Sales (Monday)
  
• Pending Home Sales (Monday)
  
• Eurozone PPI (Tuesday)
  
• Fed Bernanke testimony (Tuesday)
• ISM Services (Tuesday)
• Eurozone Retail Sales (Wednesday)
• ECB Interest Rate Event/Trichet Press Conference (Thursday)
• Initial Claims (Thursday)
• Fed Bernanke Speech (Thursday)
• Bank stress test (Thursday)
• NFP/Unemployment Rate (Friday)

Also, both the RBA and BOE have interest rate events this week, the RBA, BOE, and BOJ put out their latest monetary policy statements respectively, and SNB's Roth and Jordan have speeches. All the majors and yen crosses have major fundamentals this week in fact, so stay on the top of your game because these factors are driving money-flows and the sentiment of market participants.

Wall St.:

Both the Dow and S&P 500 managed to put in a continued strong performance the first trading day of May and this is certainly a good sign for the bulls while keeping the bears in the cave for now. I don't believe a bad NFP will be enough to knock Wall St. down, but in order for the S&P 500 and Dow to attract enough money-flows to continue marching forward, the following correlated markets will need to work in Wall St.'s favor:

1. USD Index moves lower
2. Spot crude moves higher
3. 10-year Treasury yield remains above 3.00%
4. Treasuries continue moving bearish on the short-end of the yield curve
5. No banks become nationalized as a result of the stress test 

The thing to keep in mind is, from a pure price action and price behavior standpoint, it takes more conviction buying to drive prices higher than it takes for conviction selling to drive prices lower. Prices of almost any tradeable market will drift lower simply for lack of buying and not necessarily from conviction selling.

Sunday/Monday Trading:

As we noted above, these markets have quite a bit to contend with this week. Trading the first week of the month can be challenging because it's so hectic fundamentally, and that causes many of the big market-movers to pre-position themselves ahead of key events, especially interest rate events. With all the pre-positioning and book squaring that goes on the first week of the month, my trade plan calls for strict risk and money management and paying very close attention to the time of day...

Remember, both the Forex and equities markets follow specific patterns during certain times of the day, like before Frankfurt and London closes, between the time NY closes and Tokyo opens, the 30-minutes prior to the Nikkei's open, the 60-minutes before the European cash market opens, as Chicago future's money-flows hit, etc. Don't let yourself get caught off guard by neglecting the market's patterns of behavior this week...

Gold--

The other market to keep an eye on is spot gold... gold will remain under pressure for as long as the central banks and market-movers like the IMF, World Bank, and BIS continue dropping massive tonnages of gold on the market. This is just my opinion, but I think the central banks are even finding their own reserves to be under-capitalized and they are dealing with this issue by selling gold to raise cash to pump into economic and banking stimulus. The IMF has been the most vocal and transparent about their open-market gold operations and I can assure you all the banks are doing it.

As always, it's imperative you use proper risk and money management this week... stick to taking those 0.5% entries and keeping your usable margin at 96% or better to avoid being held hostage to the market or worse. Small losses are much easier to recover from and it's a terrible thing on the mind of a trader to let a position get too far away or to let the usable margin get too low.

That's all for now. As long as market conditions allow I will do a live audio Q and A in the chat on Monday at 1000 EST / 1500 GMT. 

-David

FOMC event on Wednesday:

I haven't heard much talk or speculation in advance of tomorrow's FOMC interest rate meeting which is surprising to me. I suppose market participants think the Fed can't possibly lower rates, so it's not worth paying much attention to, but I don't necessarily agree with that view.

Fed funds lower?

Although the effective Fed Funds rate is currently set within a band of 0.00% to 0.25%, there's actually room to take that trading band lower. The Fed could pull a BOJ-type move and drop the Fed Funds trading band to something like 0.00% to 0.10%. Although I give this type of move a lower probability I'm not ruling it out and I'm prepared to see it. If the FOMC did further reduce the Fed Funds trading band obviously the USD would come under pressure, sending the USD Index lower and majors like the EUR/USD, GBP/USD, and AUD/USD higher. But, there's an even greater risk on the dollar tomorrow...

Expansion of Treasury purchases--

The more viable and probable risk on the dollar is that the FOMC announces further plans to expand their quantitative easing program. At the last FOMC meeting the Fed announced their plan to buy $300 billion worth of Treasuries. If you're new to the market or don't remember how it all played out, I'd encourage you to re-read my market commentary from that day for a re-fresher.

So, the biggest risk for the dollar will be an announcement from the Fed in the FOMC statement that they are further expanding their quantitative easing, which is really nothing more than forced currency devaluation and price-fixing of interest rates. I think if the Fed announces they are further expanding their balance sheet, the USD Index will come under pressure and the dollar would be sold-off across the board.

At this point the Fed's ability to price-fix Treasuries, which were supposed to lead to lower mortgage rates, hasn't exactly worked the way they planned. Since the start of their quantitative easing in March, Treasuries have turned bearish and have lost... so far in April Treasuries lost over 1% after losing almost 1.5% in Q1. Go Fed go!

There's really no way to predict whether or not the Fed will announce new plans to further expand their $300 billion program to buy Treasuries but it is my opinion the Fed has to expand the buying program. In fact, I give the Fed a 70% probability of announcing this to the markets tomorrow. Again, this is just my opinion and it's pure speculation. And even if they don't announce it tomorrow in the FOMC statement, I still believe their Treasury buying program will have to grow to at least $800 billion in the near-term.

FOMC statement--

Besides the Fed possibly dropping Fed Funds and announcing new measures to buy more Treasuries, it will be critical to dissect the FOMC statement because the statement will tell us about the Fed's current views on inflation, growth, housing, jobs, and the consumer. I would expect to get a lengthier FOMC statement tomorrow with more detail than what we've been given in prior statements.

In recent weeks Bernanke has been talking about positive signs in the economy. He and some of his comrades at the Fed have been subtly telling the markets that the "worst of the worst is over" in order to sustain the slight amount of confidence being built with market participants. Here again, there's no way anybody can predict what will be contained in the FOMC statement, but I'm fairly certain the markets will not get hit with any shocking or alarming rhetoric and I think the overall picture the Fed wants to paint is a brighter one.

Real-time price action example for trading EUR/USD:

Many traders who are new to understanding and using price action and the market correlated variables often ask me to explain how it all works and how they all tie in together. Well, this morning the market gave us a beautiful example for how it works and how my system takes this real-time market data to show trades that carry 95% or better probabilities of paying out.

At the 1100 EST / 1600 GMT timeframe the EUR/USD made six consecutive highers, which also corresponded perfectly to the euro failing at the 1.3085 upside key level, the S&P 500 futures (ES_cont) failed to break the 855 level after making five consecutive highers, and then spot crude failed to even get to the $50 level after making several attempts and it dropped to test the $49 level.

That's what I call a silver-platter trade... let me break it down another way:

• EUR/USD made a sequence of six consecutive highers
• Four of the six consecutive highers had a pip differential of at least 15-pips per higher
• S&P 500 futures made five consecutive highers
  
• Spot crude failed to break $50, moved lower
  
• EUR/USD failed at upside key level of 1.3085 after making three attempts to break higher 
  

So, with all that data my criteria to take a EUR/USD short at 1.3085 was met. And, based on the number of consecutive highers, based on the sequence of pip differentials, based on the price action of the EUR/USD's market correlated variables, my system showed a 98% probability of a short at 1.3085 paying me a minimum of 20-pips, and this probability is based on almost 8-years of pure EUR/USD price action patterns in addition to how equities and commodities impact upside/downside moves for the euro.

At 1142 EST the EUR/USD hit 1.3065, my 98% probability was achieved and my trade paid-out, the trade took well under an hour to pay, I had zero drawdown, and not a care or worry in the world unless an unforeseen geo-political event or rhetoric from a central banker changed the gameplan. Fortunately that was not the case and I got my 20-pips with no stress. 

Probabilities are the key--

Not every trade is going to run that smoothly and be that easy, that's just not how this market works, but in terms of not having to worry about my entry, it's a piece of cake because the whole basis for my trade is simply a probability. And it's a probability based on thousands of repeated patterns caused by human behavior, behavior that is driven by two things -- fear and greed. And that's how it works.

Is 20-pips a big deal? Of course not, lots of traders can make 20-pips but just as fast as they can make those 20-pips they'll give back another 50-pips or to the market. So the other reason I prefer to trade on probabilities is because of how it takes away the stress of drawdowns and making knee-jerk, emotional reactions which cause unneeded losses.

Plus it prevents me from being on the wrong side of the market. That short I took at 1.3085 means another trader took a long there and that trader bought at the top of a move while my probabilities were showing me it was time to short because the market had over-extended and exhausted itself and it would need to pullback before potentially testing the upside again in the future. There's no chart or tech indicator on earth that could tell me every time that exact sequence played out with the EUR/USD's 30-minute openings there's a 98% payout probability if I took a short at 1.3085, and those price action patterns that reveal the probabilities are why it negates the need for me to even look at a euro chart let alone depend on lagging indicators.

But, the EUR/USD downside didn't last long and I was glad to take my 20-pips because the markets were hit with more surprise rhetoric from an ECB member...

ECB talks euro back up:

Around 1228 EST this afternoon, as the euro was comfortably under the 1.3100 level, ECB's Bini Smaghi turned things right around with these comments:

'ECB's non-standard measures will be different from Fed; sees problem buying government debt'

On the quantitative easing issue, Bini Smaghi was very clear on his opinions:

'Quantitative easing make sense only when the interest rate is at zero or very close to zero; bringing the main policy rate too close to zero would risk hampering the functioning of the money markets as it would reduce the incentives for interbank lending'

Just as we talked about in yesterday's update, here again we have a scenario where central bank rhetoric moves the EUR/USD, and in this case the rhetoric was EUR+ sending the euro to the 1.3150+ level within two hours after his comments hit the news wires. And now we have a situation where the ECB governing council is clearly divided on the path the ECB should with their key lending rate and how the ECB should proceed with buying debt.

The Maastricht Treaty clearly forbids the ECB from buying government debt like the Fed is doing. Special provision would have to be in order to grant the ECB authority to buy German bunds or the sovereign debt of any of the sixteen EU members. I don't really see it happening but I also have no clue what the ECB's been up to the past 30-day, and there's no way of predicting what kind of backroom political deals are going down to facilitate the needs and desires of the ECB.

No matter what, with all this rhetoric flying around and various members of the ECB governing council talking out of both sides of their mouth and disagreeing on monetary policy, you can expect another circus sideshow at the next ECB rate event.

Wednesday trading:

Surprise, surprise... Consumer Confidence printed better than expected but I think we all knew that was going to happen anyway. But for tomorrow, in addition to the major FOMC event, the markets will also have to contend with US Advance GDP. This is a major piece of fundamental data and it should not be pretty. Unfortunately, I have little faith the truth will be told, especially based on recent data trends with the fundamentals. But, I do have a forecast for GDP, and my forecast is based on fact, not fiction. My forecast is for a print of -5.2%. Do I think we'll see it? No, probably not, we may see even lower than -4.5% if they want to continue playing the smoke and mirrors game, but be prepared for a volatile response in the markets no matter what the print is.

Euro--

There aren't any fundamentals that the market would consider "major" but they are to me, specifically the M3 and Private Loan data. The Eurozone needs M3 to keep moving up, not moving down and they need the velocity of their money-supply and monetary-base to start going the other direction because there's a serious threat of disinflation in the Eurozone right now.

Kiwi--

I'm not a NZD trader but it's important to note the RBNZ has a rate decision and monetary policy statement event at 1700 EST on Wednesday. Most forecasts are calling for a 50bps reduction in the RBNZ interest rate and anything more than that in addition to announcements of looser monetary policy should likely send the Kiwi lower. It could present a good opportunity for interest rate traders. I'll definitely be watching that event and making an interest rate-based trade if the opportunity is there.

JPY--

The BOJ also has an interest rate event on Wednesday. The BOJ doesn't have a set time, they meet and then make their announcement whenever they feel like it, but be on the lookout for their decision anytime past 2300 EST. With their interest rate already at 0.10% there's only a tiny bit of room they can go to further reduce rates, I suppose they could just knock them flat to zero but I'm not expecting this. What yen traders need to be ready for is the BOJ's monetary policy statement.

If the BOJ wants the yen lower, which surely has to be the case, they may use their monetary policy and statement to send it lower. Economically, Japan remains in a dire situation and a strong currency is one of their worst enemies right now.

Lastly, in the spirit of things, I'd like to give my own personal report card for the Obama administration's first 100-days in office:

• Spending $1.1 trillion bailing out insolvent companies: F
• Nominating tax-evaders to high level government positions: D
• Exceeding George Bush's prior record-breaking deficit spending: F++
• Launching the promised 500K new "shovel-ready" jobs by Q2: F-
• Granting unconstitutional powers of authority to the Fed and Treasury: F+
• Creating the largest budget in US history for a single year ($3.6 trillion): F+
• Asserting government control over CEO's and corporate management: F+
• Increasing government funding for education, science, and technology: D-
  
• First lady gains fame for her $5,000 dresses while 6.1 MILL are unemployed: F-
  
• Adding 14 new "czars" to positions to expand government control without congressional oversight: F-
  

On a positive note, I think one of the best moves the Obama administration has made was submitting a bid for the US to host the World Cup in 2018, other than that I'm not seeing much to get excited over... and just for the record, I'm 100% bi-partisan, I don't like or trust Democrats or Republicans, they are both devils and having just a two-party system in a so-called democracy is a joke.

That's all I've got for now, as always, be smart with your risk and money management, especially with the big central bank interest rate events tomorrow, it could be a wild one...

-David

For this week's market outlook I cover a lot of ground and I'm going in all kinds of different directions with all tradeable markets -- Forex, commodities, equities, bonds, but I'm going to finish it off with a few basics we traders need to keep in the forefront of our minds as we navigate our way through all the fundamentals, geo-politics, and manipulations that effect moves in the markets.

There are many complicated factors at play right now and the best way we can combat all the "noise" is to keep it simple, stay focused on the underlying fundamentals that move markets, and not forget the core basics for how and why we take a trade...

The cousins of Forex:

The final two days last week while I was trading the yen crosses I noticed an interesting correlation shift between the yens and their majors, specifically between the EUR/JPY and its cousin, the EUR/USD and the GBP/JPY and its cousin, the GBP/USD. I'll get to that part in a moment, but before we dissect that potential correlation shift we need to put some things in perspective in regards to the Japanese yen.  

Overall, the JPY put in a rather strong week, especially against the USD, even in the face of equities that were able to rally after selling-off earlier in the week. Under "normal" market conditions, the exact opposite would have been the case as riskier appetites send their money-flows into equities and out of the yen, and based on that fairly solid and steady market correlation, the yen crosses would have been driven higher as the S&P 500 and Dow made back their losses.

That wasn't exactly the case for one of the two yen crosses... earlier in the week I gave a GJ support level of 141.50 which did manage to hold solid all week, but there was a definite shift in the correlation between the GU, GJ, and equities... both the EUR/USD and GBP/USD managed to put in a rather strong performance on Thursday and Friday, however, the GBP/JPY sold-off to a much larger degree than the EUR/JPY even though they generally follow each other when equities are strong and their cousins remain well supported, which was the case at the end of last week.

On Friday the EUR/JPY made its high for the day and remained well supported to the upside just as the EUR/USD was putting in the same exact performance. The GBP/USD also remained fairly supported yet the GBP/JPY was sold-off with conviction. As the euro was testing the 1.3300 level its cousin was testing the 129.00 level, which were their top of the range highs, correspondingly, while the pound sterling was testing its highs at the 1.4770 level and was able to remain supported above 1.4700, the GJ was plummeting down to the 142.50 level which was 200-points lower than its high. Within the GJ's price action it showed zero signs it should be bought and was screaming "sell me" from the time NY opened and right through the close. 

So why would the EU and EJ maintain its positive correlation and maintain its ability to move in tandem with equities while the GU and GJ went in opposite directions? Now before we go any further, let me just say this is my own theory and opinion, so take it for what it's worth...

As technical as the GBP/JPY may be, the markets were hit with some massively negative fundamental data out of the UK and even though the GBP/USD found a way to recover back above the 1.4750 level on Friday, I think it's possible the pound sterling/yen correlation is showing risk aversion towards the UK economy, based on the UK's fundamentals which are growing alarmingly negative.

The dollars fundamentals were bad last week and the yen gained a lot of ground on dollar. The euro's fundamentals were great last week and the euro gained on yen. The pound sterling's fundamentals were abysmal and the yen gained on the pound... are you seeing a pattern here? I am. As risk aversion still remains the order of the day, to me it's obvious that the yen was the weakest against the currency which had the strongest fundamentals, and that currency was clearly the euro, not the dollar or the pound sterling.

So, what exactly is putting the pound at such risk? Read on...

UK sovereign debt risk:

Last week Chancellor Darling announced the UK's need to borrow and print more money, grow the debt-to-GDP ratio, and to raise taxes. I won't waste time re-capping those issues, I already wrote a commentary on this on 22-April which you can read here. 

Not only do those debt and budgetary issues put the GBP at risk, the potential for a ratings downgrade on UK sovereign debt adds a tremendous amount of risk. Just like Treasuries and Bunds, Gilts are AAA rated but it's my opinion their rating is now at risk. With UK government expenses running almost 125% higher than revenues, how can their sovereign debt rating not be at risk?

The way the UK is dealing with the staggering expense-to-revenue situation is by printing more money but anybody with half a brain cell in their head knows that's not an answer to the problem. In a perfect and honest world the UK's debt rating would have already been reduced to at least emerging market levels (BBB) even though their budget, expense-to-revenue, and debt-to-GDP ratios rival that of any third world country. At this point Great Britain's monetary and fiscal situation reminds me of another island, Haiti.

According to the latest UK debt figures, the DMO will need to raise an additional £197 billion in public debt in 2010, £154 billion in 2012 and 2013, and £125 billion in 2013 and 2014. So, what does all this mean for us as Forex traders, especially for those that trade the pound? It's very simple, and it won't matter what your chart or your techs say, should Standard and Poors, Moodys, or Fitch drop the triple-A rating on Gilts, the pound sterling will be brutalized, end of story. 

I don't care what any chart or tech indicator is showing or what any trader thinks they are seeing on their charts... Fibonacci doesn't stand a chance against S&P, Moodys, and Fitch... those ratings agencies will crush any chart and will crush Fibonacci and all indicators any day of the week. My point -- if you trade the GBP you better keep your eyes and ears open for this potential risk on the pound.

Treasury bull bubble ready to burst:

This week the Treasury is set to auction $101 billion worth of new debt. I'm not even sure why they are referring to these events that involve the Fed buying US debt as a "Treasury auction"... it would be the equivalent of me listing a product on ebay, borrowing money from a bank at 0% interest, bidding up my own product, and then buying it myself with the bank's money and promising the bank I'll repay them when I re-sell my product again sometime in the future.

There's not even any logical sense in this sham the Fed and Treasury are running and it's going to end up backfiring on them because this type of manipulation will burst the bull bubble in Treasuries, it will send the yield on the 10-year far above the 3.00% level and that will put downside pressure on mortgage lending rates making it even harder for potential homeowners to borrow which will even further cap home prices and prevent them from rising. Yeah, that sounds like a great plan to me... and then we have the whole issue for how this sham floods the money-supply which I don't even have time to get in to right now.

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. But, with $101 billion worth of fresh US debt flooding the markets this week, I believe equities will be one of the beneficiaries...

Wall St. rally to continue:

What's going to make Wall St. keep pressing on northward? One of the main factors should be exactly I was talking about in the above commentary, the Fed buying Treasuries. There's more to it than just that and a lot of it has to do with overall market sentiment in addition to what we know about human behavior; what I've been teaching about human behavior in relation to price action and price patterns...

Last Friday Ford was the main catalyst that helped power the Dow and S&P 500 over their respective resistance levels by announcing they only took a $1.4 billion loss in Q1. So you want another good reason why I'm not calling an end to the Wall St. rally? Because when we're in an environment where a $1+ billion loss is viewed as a bright spot for the economy and a bullish sign for equities, what in the world is going to take to bring the Dow and S&P 500 tumbling back down below support levels?

Oh, and if you're an American taxpayer, you just lent GM another $2 billion on Friday and that too was viewed positively by Wall St. and even GM's stock went up after that news. I suppose all those threats by the government to take GM into bankruptcy were just that, empty threats... and according to my numbers GM's now received $15 billion worth of taxpayer bailouts yet they still remain insolvent and on a sinking ship but Wall St. is choosing to ignore the situation in Detroit and look the other way.

And while we're on the subject of the automakers, be advised there's a good probability Chrysler will file for bankruptcy as early as this coming Friday. There's still time for Fiat and Chrysler to pull a deal together, but time is running very short and the last we heard from DC is that they will not re-bailout Chrysler as they have been doing with GM.

I was able to forecast the start of Wall St.'s rally nine days before it took hold and I feel confident at this point in calling a continuation of the rally for at least the short-term. As long we stay focused on the underlying fundamentals of the market and properly gauge overall market sentiment, it should be fairly clear when the rally will fizzle out, but for now I see it continuing right into May unless we get a major fundamental set-back or unforeseen geo-political event.

Stress test reveals unconstitutional powers seized by Fed & Treasury:

What is acting?

My definition: acting, in its purest essence, is simply convincing your audience of something that is not true.

To me, this whole stress-test is nothing more than an act... an act put on by the Fed and Treasury to convince their audience they are regulating the banking system and backstopping financial institutions. Their audience are market participants and politicians. The reason for the act is to appease both sides in order to convince them they need the Fed and Treasury, with the ultimate goal of getting more taxpayer money and wielding more control over the banking system, but to do it in a way that eludes the appearance of nationalization.

The US banking system, by way of legislation from congress, makes no provision for the Treasury or Fed to take the roles they have since the banking and financial system first  fractured in March of 2008 with Bear Stearns. According to congressional legislation and US federal banking law, the Office of Currency Comptroller and the FDIC are the two regulatory agencies assigned the tasks of supervising and regulating the entire US banking system, not the Fed or Treasury. The Fed and Treasury are clearly on a major power-grab mission.

In just the past 12-months the Fed and Treasury have seized remarkable authorities of power; powers that are not granted to them by congress and are actually unconstitutional. The scariest thing about this stress test is not what the results will reveal but how much power and control the Fed and Treasury have snatched away from Wall St. and Washington DC.

Just some food for thought...

Oh, and while we're at it, time for a failed bank update... last Friday four more US banks failed bringing the total number of bank failures to 29 in 2009. In the year 2008 a total of 25 banks failed, so we're well on pace for a strong year of bank failures. And here's a little bit of trivia... there's only be one industrialized G10 nation that hasn't had a bank failure so far during the global financial turmoil. Can you guess which one? I'll give you the answer at the end of this update...   

Gold and crude:

Despite some alarming disinflationary fundamentals out of the US and Europe, spot gold has managed to stay well supported above that key $865 level we talked about earlier this month. Remember, that level has been tested over and over and over again since the start of the year and has proved resilient, and just like anything else, if it can't go down, there's only one other way it can go...

Spot gold and the USD Index remains slightly disjointed but as we saw on Friday, it was like old times again with the euro rising, the dollar falling, and spot gold, crude, and equities all gaining. That is a very fundamental correlation for the markets and was certainly a welcomed sign of some normalcy.

Most of gold's losses a few weeks ago are easily traced back to the fact that we know central banks like the ECB, BOE, plus the IMF were unloading gold on the market to raise cash. In fact, the IMF was quite clear on this and didn't make any attempts to hide what they were doing, and that's why I never took my bullish bias off of gold because there's only so much selling they can do. And just as with equities, once the surge in US M3 money-supply and the monetary base begins pressuring prices, gold should have no problem continuing to the upside. But, this may take some time to play out, so be patient.

The key for this week is to keep an eye on how spot gold responds to the fundamentals and any possible fear or risk aversion plays that happen in the markets. As far as crude is concerned, I think traders will have to take a bullish tone on this commodity as well.

Last week we saw that Crude Inventories showed their biggest builds in almost 20-years yet crude was able to rally below the $50 level and end the week on a stronger bullish tone. Here again we have another scenario where even bad news isn't quite enough to knock this commodity down. Should equities continue their rally and break through some upside resistance, I see spot crude having no trouble doing the same.

Forex:

A few times last week I gave a the 1.2901 price as a mega key level for the EUR/USD and it did hold and we saw the euro end the week higher than where it started. At the start of this week I would expect the same type of market sentiment to prevail as long as the euro and all its correlated markets stay on course. Obviously we've had the G7 and IMF meetings in DC which could cause some shifts in money-flows, but I'm not expecting any major shocks here.

Fundamentally, it's another monumental week as we have very key inflation, growth, consumer, manufacturing, and production data for the euro and dollar. In addition, we have the FOMC on Wednesday and a European banking holiday on Friday. There's so many fundamentals on the books this week I don't have the time and space to cover them all in this outlook, but we'll break them down in the daily updates.

Keep a close eye on the USD Index. Last week it showed some signs it was fracturing and should the trend continue, you know exactly what's going to happen, it's not rocket science and you don't need any techs to make sense of it all and to figure out what the end result will be for pairs like the EUR/USD, USD/CHF, and AUD/USD...

Lastly, I want to give traders a few reminders; back to basics kind of stuff. As you're trading this week I want to encourage you to keep it simple and stay on top of the underlying fundamentals that move markets. It doesn't matter if you're a tech trader or you pray to the Greek god of Ploutos to find your trades, be mindful of the basics of price action and how human behavior determines price patterns:

• Fear and greed
  
• Path of least resistance
• Over-extension and over-exhaustion
• Price action of correlated markets
  
• Central bank rhetoric; geo-politics
• Risk sentiment of market participants
  

That's all for now. We covered a lot of territory today but as you know there's a lot of madness in the markets. Re-read this update a few times if you have to, I don't want any traders getting caught by surprise or depending on techs too much to show them the way... I'll post EUR/USD key levels before Wall St. opens on Monday and we'll do a live audio Q and A session in the chat at 1000 EST / 1500 GMT.

-David

Answer to trivia: Canada