The ECB would buy a peripheral country's bonds if necessary

The Big Picture

All of a sudden, the markets remember risk. After the Italian vote resulted in a hung parliament, stock markets around the world fell sharply, the VIX index soared 34%, gold rallied, and even the yen came back in fashion as a “safe haven” trade.

The anti-establishment result of the Italian election was clear from the fact that more than half the voters backed parties that reject the EU political consensus and the austerity that Brussels (backed by Bonn) says is necessary to keep the Eurozone together. The result raises the awkward question of whether the ECB will still be committed to “do everything necessary” to keep the euro together even if the countries in question don’t share that commitment.

Today we have several housing-related indicators out of the US, including new home sales and the S&P/Case-Shiller Home prices. No major indicators out of Europe. In any event, the markets will be watching political developments in Italy, where Berlusconi has called for a recount. The Italian Treasury sells six-month bills today and five- and 10-year notes tomorrow, which should be a good test of investor sentiment.

The Market

EUR/USD

Draghi’s promise to keep the euro together involved a quid pro quo: the ECB would buy a peripheral country’s bonds if necessary, but only if the country accepts stringent economic conditions. However the Italian voters have clearly rejected the kinds of conditions that the EU establishment would impose. That brings breakup risk back into the euro and is likely to send the single currency lower across the board until this tail risk is once again removed.

“The pair plunged yesterday in extremely volatile trading. The 270 pip high-low variance was the greatest in 16 months. The inability to break out from the strong resistance level and the close below the 38.2% retracement level of the July-February up move points to a furthering of this downtrend. With our 1.3116 target met we eye 1.302, noting possible resistance now at 1.312-1.314, which sees the 38.2% retracement level and the lower trendline of the downward channel congregate. Day traders may want to consider these levels as their targets today given the likelihood of a rebound on account of the plunge yesterday and the price extremes relative to the Bollinger Bands. Longer term traders may want to note 1.291 as a target, close to the 50% retracement level.”

USD/JPY

In Japan, more indications that PM Abe will nominate Asian Development Bank head H. Kuroda for Bank of Japan Governor. Kuroda has long called for a more stimulative policy from the BoJ and would not stand in the way of a higher USD/JPY. Nonetheless the market was taking risk off yesterday and USD/JPY collapsed. We see it moving higher again once stability comes back, whenever that may be.

“USD/JPY broke out of its upward channel. The single day down move was of such magnitude that it caused a 23.6% retracement of the up move since mid-November. This support level at 91 was rather strong as it also concentrates a former trendline support and the lower Bollinger Band. With this support noted, we target higher, placing an initial target of 93.4.”

USD/CHF

As money flowed out of the euro, it went back to another safe haven currency: the Swiss franc. The franc gained against both EUR and USD. Of course there is a limit to how low EUR/CHF can go, and we’re almost there, but USD/CHF can still move lower.

“USD/CHF’s downward sloping trading channel looks like it will continue, given the 14-day Stochastics crossover in overbought territory and an imminent RSI-MA crossover. The fact that we are currently lying on the upper trendline of a downward sloping channel also gives us confidence to short the pair. It’s of some concern that prices have been trading the past few days between the 50 and 200 day MA, but it seems likely that the 200D MA and the upper Bollinger Band will act as resistance. Possible trailing targets for the pair are 0.922, 0.917 and 0.911.”

Gold

Gold’s correction looks set to continue after it broke out from the 23.6% retracement level. With the uncertainty in Europe spiking and the VIX rocketing, we may see a temporary return to the safe haven. $1603, the 38.2% retracement level seems like a valid target for the day, although our longer term view remains bearish.

Oil

Oil did not manage to sustain its early session gains, closing near its low, at the 50% retracement level of the mid-December-mid-February up move. We now see $92.5 as a possible, yet weak, resistance, targeting $91, close to the 61.8% retracement level. With a looming 9D-50D crossover, which has proven rather reliable on WTI, we have confidence in this target despite the gains today. That price may also act as a strong support as it also coincides with the 200D MA.