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Wednesday May 12, 2010 - 00:26:52 GMT
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Stocks Fail to Hold Gains; Traders Still Worried about Risk

U.S. stock markets failed to hold onto earlier gains and finished lower for the session. At the midsession, equities were trading higher as speculation that a new U.K. government had been formed helped draw buyers into the market while triggering liquidation by weaker shorts. The news out of the U.K. was positive because it indicated that the parliament would have the power to shore up the country’s budget woes while helping it improve its credit rating.


Upside momentum was building throughout the day in the June E-mini S&P 500 as the market cleared a key retracement area at 1155.25. By the end of the day however, the market had settled back below this level. A trade through 1136.25 could trigger further weakness on Wednesday.


June Treasury Bonds were under pressure most of the day following an early morning surge. Traders were selling T-Bonds as they lightened up on safe investments following a recovery in the stock market. The last session sell-off in the equity markets brought the T-Bond buyers back however into the close. Although this morning’s Treasury auction was well received, T-Bonds weakened. Increased supply concerns were the main reason behind the weakness.  Today’s action indicates that investors are still willing to buy T-Bonds for safety.


The weaker Euro helped drive June Gold to a new all-time high. Investors are treating gold as a safe-haven investment out of fear that renewed problems in the Euro Zone will lead to a collapse in the Euro. Traders are choosing to use gold as a hedge against the risk of holding paper currencies. Some traders also feel that inflation will increase now that EU is flooding the economic system with excess liquidity.


June Crude Oil tried to recover from earlier weakness but failed into the close. The intraday strength in the Euro and British Pound helped to increase demand for risk, but by the end of the day, the weaker Euro pressured demand for higher risk assets. Fundamentally, OPEC’s announcement that demand from China will pick up the slack caused by lower demand out of the Euro Zone provided support early in the session.


The June British Pound advanced after it was reported that an agreement to create a new government had been reached. Traders celebrated the news that the Conservative party and the Liberal Democrats had formed a coalition to create a majority in the Parliament. The move by both parties helped put an end to the long-standing rule of Prime Minister Gordon Brown and the Labour Party.


The formation of a new government is seen as a positive for the British Pound at this time because it provides clarity to an almost dire situation. For weeks the Sterling has succumbed to selling pressure due to the possibility of a hung parliament. This situation would have created a problem because it would have made it virtually impossible for the new government to enact the austere fiscal measures needed to balance the budget and reduce the country’s debt.


The clarity provided by the “new coalition” between the Conservatives and the Liberal Democrats comes at an important time because of the events taking place in the Euro Zone. The formation of a new government will help to provide the psychological boost the British Pound needs to reverse the current down trend.


Technically, the Sterling rallied after successfully testing a minor retracement zone at 1.4765 to 1.4695. The subsequent bottoming action and upside reversal helped form a secondary higher bottom which attracted fresh buyers. Based on the main range of 1.5523 to 1.4474, traders should look for a short-covering rally to the first 50% retracement level at 1.4998. Upside momentum through this level could drive this market into the next retracement point at 1.5122.


Despite the strength in the British Pound and the major commodity linked currencies, the U.S. Dollar Index managed to post a modest gain on Monday. Most of this was due to how the trade weighted index is formulated. The index would have finished even higher had the Dollar/Yen been able to hold on to its earlier gains.


After a one day reprieve following the announcement of the European Union’s $1 trillion bailout package, the Euro once again traded weaker throughout the trading session. The current downside momentum suggests that the market has the power to take out the recent bottom at 1.2518.


The historic announcement by the EU over the week-end failed to generate enough investor confidence to support the Euro, but more importantly reaffirmed that the destiny of the Euro is clearly in the hands of the hedge funds and large traders.


The fact that the June Euro traded sharply lower ahead of the New York session was a strong sign that the euphoria of the past 24-hours was over and that reality had returned to the Forex markets. Simply stated, Monday’s trading action demonstrated that traders accepted the fact that the EU’s aid package was a short-term fix, but that over the long-term, the economic problems in the Euro Zone would continue to exist long after the new money was sucked into the financial system. The post-bailout package sell-off in the Euro also served as proof that the market doesn’t believe that a country solves a debt crisis by issuing more debt.


The rejection by the market of the rescue plan served as notice to the EU community that there is little doubt that the only way to avoid the spread of contaminated debt in the Euro Zone is to implement further austerity measures rather than pile debt upon debt.


Tuesday’s weakness the Euro was also a strong indication that the market was discounting the inevitable that the debt of Greece, Spain and Portugal are getting very close to being declared “junk” by the credit rating services.


Besides the fear of contagion over the short-run, Euro investors are dealing with the real possibility that the bailout package will be a drain on European economic growth. The implementation of the unprecedented bailout package means that resources will be used to fill in “holes” in the economy rather than sow the seeds for future prosperity.


Flooding the market with excess liquidity will force the European Central Bank to keep interest rates low for a longer period of time. As other major central banks begin to withdraw stimulus and hike interest rates, investors will shift investments out of the Euro Zone and into these higher yielding currencies putting additional pressure on the Euro.



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