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Market Technical Review: Friday Confusion

  • Written by Syndicated Publisher 243 Comments243 Comments Comments
    February 12, 2012

    Today’s close was another example of a confused equity market. A market were various securities do their own thing. The last 15 minutes of the session ES (SPX futures) caught a bid and came off their lows while the EMD (mid cap futures) and TF (small cap futures) moved lower. In fact both EMD and TF were weaker by .5% and .7% respectively on the session (as of 4PM).

    That type of price action was more indicative of people unwinding hedges and or meeting margin calls versus positioning for the weekend. There simply seems to be no cohesion and or leadership in the market right now.

    Even more telling was right after the bell where equity futures trade for an additional 15 minutes. ES has moved up about 5 handles (points) while EMD and TF have not. It is just very strange price action.

    Something not discussed much lately but worthy of a reminder are the details of the credit event. It’s easy to forget some behind the seasons events that are likely driving this deleveraging that I continue to suspect we are seeing in the capital markets.

    ECB LTRO Unintended Consequences

    Zero Hedge ran a great piece (found here) highlighting one of the unintended consequences of the ECB’s LTRO program. In trying to unfreeze a frozen interbank lending market the ECB actions have negatively impacted the senior unsecured credit market.

    In other words creditors who were more senior or closer in line to be paid in the event of a default have been pushed further down as the ECB has now become senior to them. What this simply means are those unsecured creditors are now viewing this change in position as a higher risk and thus this market is underperforming.

    EURO Basis Swap Improving

    One of the positive outcomes of the Fed USD swap lines is the improvement in the EUR Basis Swap or rates paid to swap EUR and USD as shown on the chart below (less negative is good). But this improvement does not mean the demand for USD has declined but rather shifted.

    Use of the Fed swap lines has moved to the highest levels since being instituted. In other words the “lender of last resort” policies of the Fed is simply moving this demand for USD behind the scenes.




    If you are an options trader you are well aware of the price action in the vix and excited to see this move. When the vix moves higher so does the implied volatility of options. Simply stated a higher implied volatility (IV) means investors are willing to pay more for the same option. In other words options traders can begin making money not just by price changes of the underlying security but also the rising IV.

    If you are not an options trader the breakout in the vix today should still be on your radar. In a day the markets were down less than 1% the vix was up 11%. That’s a big move in volatility for a rather small move in equity. The descending wedge pattern has contained price for six months with no failures. Thursday saw the first close outside of this pattern and today the vix just took off. The move here looks very bullish for the vix.

    Bottom Line

    Today was the first real sign of weakness in equity in a while. Treasury futures bounced well off support today while the currencies, specifically the AUD/USD put in a major reversal taking out the neckline and thus invalidating the inverted head and shoulder’s pattern.

    Still it is no reason for bears to celebrate here. This could be a pause before higher prices in equity. The breakout in the vix though was a rather bearish omen. If the currencies, specifically the EUR/AUD and AUD/USD can continue their current reversal patterns it will put more pressure on equity while pushing capital into treasury.

    Images: Flickr (licence attribution)

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