You must have read by now that about 70% of activity in currency markets over the last 2 years has been largely driven by risk appetite, with equity indices being the primary independent variable steering FX flows. But there are times when currencies peak or bottom 2-3 days before equities begin to turnaround. The more resounding and recent example was the March 4th bottom in the EURUSD (peak in the US dollar), which occurred 2 days before the low in the major stocks indices. That low in the EURUSD coincided with the peak in the US dollar index at 89.62, which happened to fall right below the 38% retracement of the major decline from the 2002 high (top of dollar bull market) to the all time low of March 2008. On March 10th, we warned the dollar index would reach today's level of 84, 10 year yields would exceed 3% and S&P500 would regain the 800 level, with each level prominently displayed.
So does today's euro test of its 200-day MA for the first time in 9 months forewarn a looming top in equities?Various measures of sentiment suggest the current 35% rally in the S&P500 from its March lows has the configurations of a typical bear market rally, where sentiment is 3x as much as as that of bull market rallies. What may have been an attractive proposition to buy stocks 8 weeks ago when indices were at 17-year lows has turned into a momentum trade fuelled by the helium of second derivative, postulating that slowing pace of contraction warrants the fastest (magnitude over time) bear market rally in history. Will stocks be right to rally another 3% on Friday in the event that US jobs turned out to lose only half a million instead of the forecast 600K?
Today's ECB announcement to buy covered bonds triggered a knee-jerk drop but the decline in US jobless claims towards the 600K level (lowest since Jan) further boosted risk appetite at the expense of the dollar, yen and bond prices and to the benefit of EUR and commodity currencies. Considering the risks that the current market recovery (rising equities/falling dollar) may be overdone, Forex markets are increasingly cautious whether to the push the envelope beyond the 200-day moving average (best measure of long term trend). EURSD's rally stopped right at its own 200-day MA ($1.3470), while S&P500 remains 40 pts below its 200-day MA (960).
GOLDEN IMPLICATION: As metals (and rest of commodities) embraced the green shoots story and managed to rally along with stocks over the past 2 weeks, a possible win-win scenario emerges for metals (gold and silver), whereby (i) further gains in equities would fuel metals on improved global risk appetite (what's good for China is good for metals) and (ii) any retreat in equities (and banks) could fuel the rotation from financials into metals and ETFs; and (iii) each of the 3 attempts to break below gold's 200-day MA have failed over the past 4 weeks. $935 appears as the initial target for gold, followed by $975. A clear break of $1,100 isn't seen until end of Q2.
With the EURUSD testing its 200-day MA, the FTSE-100 doing the same and the S&P500 and Dow not far behind, measures of risk appetite in FX and equities are pushing the envelopes. The trade in gold and silver is already taking place. In FX, scaling up short positions n CAD, NZD and GBP vs USD and JPY could well be the emerging FX trade as each bank sets to make the case with its own version of stress tests.