European Financial Problems Fuels Equity Market Sell−Off

James Hyerczyk from ForexHound.com at 01/29/10

U.S. stock indices sold off early in the trading session as fear swept through the markets. News that Greece’s budget problems could escalate along with Portugal sent traders into the Dollar and Japanese Yen and out of higher risk assets. Lower than expected U.S. economic reports also contributed to the weakness as traders liquidated positions in anticipation of a slowdown in the economy.  All three major indices reached major retracement zones on the downside which softened the break and let to a strong midday retracement. What appeared to be panic selling to some may have actually been a normal retracement.

The March E-mini S&P 500 has formed a range between 1148.00 to 1078.50. This makes 1113.25 to 1121.50 a potential upside target.  The charts are also indicating a possible rally to 1842.00 to 1855.50 in the March E-mini NASDAQ and to 10371 to 10445 in the March E-mini Dow.

Despite the near panic selling in the stock indices and an increase in demand for safety, pressure remained on the March Treasury Bonds and March Treasury Notes. This could mean that the stock break was emotional rather than fundamental.

Yesterday’s Fed report signaled that it is getting closer to hiking interest rates. The news that the Fed is ending its quantitative easing program on schedule at the end of March is likely to put upside pressure on yields. Tuesday’s closing price reversal top which started inside a major retracement zone is helping to pressure the March Bonds. All indications are for a possible break back to 116’06.

February Gold had a volatile day. Overnight the market dipped lower, but then failed in an attempt to rally as the Dollar began to strengthen shortly after the opening. The trend is up in the Dollar which should keep pressure on gold, although oversold conditions make this market ripe for a short-covering rally back to $1119.10.  A break under $1075.20 could trigger an acceleration to the downside. The bigger picture indicates that this market could collapse another $50 to $100 if speculators decide to liquidate positions.

March Crude Oil found support overnight ahead of the December bottom at 72.53. The test of this price encouraged shorts to cover positions while attracting bottom pickers. The fundamentals are still bearish because of low demand and higher inventories. Renewed interest in higher risk assets could trigger a short-covering rally however.  The charts indicate there is plenty of room to the upside with 78.99 a potential upside target.

The Japanese Yen rose on Thursday as investors shifted assets out of the troubled Euro Zone on renewed budget turmoil in Greece.  A spike in the cost to insure Greece’s sovereign debt triggered a flight to safety rally which fueled a turnaround in the Yen after earlier weakness.  News that a similar situation is developing in Portugal also contributed to the Yen’s strength.  The Euro fell to it lowest level against the Dollar as the news broke.

Traders had been cautiously removing risk from the Euro the past couple of days after a report earlier in the week showed great interest in a possible bailout bond issuance from Greece. Today’s action indicates that the situation is growing worse and that the Yen may soar at the expense of the Euro over the short-run.

After trading relatively flat in the hours before the New York opening, the U.S. Dollar strengthened close to midday as investor sentiment shifted back toward safety.  Late yesterday and overnight, the Dollar appeared to be ready to weaken as demand for higher risk assets began to pick up following upbeat news from the Fed and a well-received speech from President Obama.

Shortly before the New York opening, news began to leak about Greece debt concerns causing the U.S. stock market to sell sold off.  The release of less than stellar U.S. economic reports triggered additional selling pressure as investors pared equity market positions in anticipation of an economic slowdown. This rattled traders who then began selling higher price assets while seeking safety in the lower yielding U.S. Dollar and Japanese Yen.

The March Euro traded under pressure throughout the session while taking out sell stops under the psychological 1.40 level. Today’s selling pressure was been triggered by news that Greece’s budget woes have resurfaced, sending the price to insure its debt against default to a new high.  For several days, traders had become complacent while under the belief that a new bond issuance would make the Greek debt problems go away.  1.3800 remains the most likely downside target.

The British Pound is traded lower but remained inside of its five day range. It’s hard to tell at this time which direction investors prefer.  Fear, and demand for lower risk is likely to drive the market lower. Renewed confidence in the economy could limit losses or fuel the start of a rally.

Demand for safer assets helped turnaround the March Japanese Yen, erasing earlier losses. During the wee hours of the morning, the Dollar was rallying versus the Yen after completing a 50% retracement and a closing price reversal bottom. The catalyst for the rally was an upbeat statement by the Fed and optimism generated by Obama’s speech. A sell-off in U.S. equity markets and budget problems in Greece and Portugal, however, sent traders scrambling for safety, sending the Japanese Yen higher. This currency pair is probably the best indicator as to how bad the situation is between Greece and the Euro Zone.

Oversold conditions and profit-taking helped to underpin the March Canadian Dollar early but the sell-off in U.S. equity markets changed risk sentiment, triggering an intraday reversal. Look for the Canadian Dollar to feel pressure as long as investors continue to shun risk. Lower crude oil and gold also contributed to the weakness in the Canadian Dollar.

The March Swiss Franc was never able to get on track after an overnight break took this market through the December low at .9522.  A new main top has been formed at .9647.  This market is rapidly approaching oversold status and could begin a correction at any time. Watch for a closing price reversal to signal the formation of a bottom. Weakening gold and the possibility of an intervention by the Swiss National Bank are the fundamentals driving this market lower at this time.