If we look at the S&P500, we can see the opposite. What can we conclude from these moves?
- The bulls took control and since we closed above Thursday's high, the reversal is "confirmed."
- The Santa Claus rally returned in full force.
- The market shook out weak hands.
Also, the 50MA acted soundly as support.
None of these "explanations" provide much of an understanding of what happened... they even do not provide a valid scenario for the near future. I am not sure I can provide such a scenario either, but at least I will not fall into a simplified analysis.
The horizontal axis of the figure below shows the difference between the US 10Y rates and the German 10Y rates. The higher the figure, the more attractive US assets. The red trend line indicates that a higher differential puts pressure on the Euro.
Each point is taken every two weeks. When a point is below the trend line, this indicates that the market anticipates a higher Bond/Bund rate differential. Investors front run the ECB by buying Bunds. When the ECB comes to the market or announce that it will increase its QE, then German rates decrease and the purchased Bunds gain value.
This was what happened between November 4 and November 16 (Bund rates decreased from 0.7% to 0.53%.) On November 30, the Euro/US$ decreased, showing expectations of a higher rate differential. However, On December 3, the ECB decided not to extend its QE right away and the relationship between exchange rates/interest rate differentials reverted back to the left.
But we can see that the Dec 4 point is still below the trend line. This is to say that the market expects higher differentials between the Bonds/Bunds. In other words, the market expect a US Fed rate increase next week.
But we can see that the 10Y were bought after the Jobs report... and everything else followed up on a Draghi reversal regarding the ECB unlimited balance sheet (Which is true only if Germany wants it to be so)
We can see below that large stocks attracted most money, while the Cumulative Tick was still weak on Friday.
Gold bounced higher on Draghi's comments regarding the limitless balance sheet.
Oil reacted poorly to the last OPEP decision to continue pumping... and energy was caught between the general equities push up and the oil weakness.
Conclusions:
The dramatic increase of the Euro on Thursday did not force more of the carry trade unwind, because of Draghi's soothing comments.
But these comments did not reverse the Euro's bounce; they only affected assets prices. The question is why...
I would not be surprised if a few Forex traders went bust, but mostly I think that a volatility spike in the Euro/US$ will have consequences on the risk level. I would say that even if we do not witness a large Forex based credit event, most international investment houses will be forced to adapt their positions in order to reflect the currencies volatility. This means less leverage, less margin, less carry-trade.
On top of this, we have the whole energy sector that feels the weight of low oil prices and the good jobs report guaranteeing us a 0.25% rate increase on Wednesday.
But... Santa Claus.
Do we dare to bet on a Santa Claus rally here?
