Just Keep Digging

No man's life, liberty, or property. is safe. while the legislature is in session. - Mark Twain (1866) .

You see a lot of stupid comments made about the financial crisis and what should be done about it, and one of the most dangerous was made over the weekend by Vince Cable, the UK Business Secretary, when he proposed that the ECB should be given unlimited powers to support the Euro and the region's debt-ridden economies. You can see the full article at Bloomberg here.

Why is this so stupid? Simply because it is in effect proposing that the Euro-area countries assume joint and several liability for the debts of all the members of the group. Why is that so stupid? Because the only thing keeping the weaker members of the group on the path of reform is the threat that they might be allowed to default in a disorderly manner, and then have to take the consequences of that default outside the protective umbrella of the Euro zone. As soon as the Germans, French and other still solvent members of the zone assume guarantor responsibility for the debts of the PIIGS, then they assume all of their liabilities while losing any real power over the PIIGS to enforce reform. Like much of the action taken to resolve this debt crisis, it is a step into the unknown on little more than a fond hope that everything will somehow turn out ok.

Of course Cable isn't the first fool holding forth on this subject with no real idea of the implications of what he was saying. On 18th March 2005 Jean-Claude Trichet, President of the ECB then and until recently, noted with approval that 'government bond yields have become nearly perfectly correlated in the euro area'. He went on to say that 'the second key success of the euro relates to the convergence of long-term market interest rates towards the best performers in terms of credibility and low interest rates.'

This was a breathtaking statement both at the time and in retrospect, as Trichet was noting with approval a phenomenon which demonstrated an implicit assumption from bond markets that the stronger members of the Euro zone would guarantee the debts of the weaker, and in the absence of any such guarantee, was evidence of a massive mispricing of risk by the bond markets, that would allow profligate members of the zone to continue unsustainable policies which are now not only threatening to bankrupt themselves, but also the solvent members of the zone in the event that they should now choose to stand behind the PIIGS.

Fortunately for the Euro zone, the german voters are heavily against Cable's proposed next step to 'solve' the Euro crisis, and it seems likely that any german politician or party that backs this step would be punished heavily in future elections. The Euro zone has already watched a solvent nation bring itself to the brink of bankruptcy by guaranteeing debts that it should not have done, and there's no appetite in Germany to become the next Ireland.

Short term though, the Euro broke the declining channel on Friday, and new governments promising to credibly back austerity measures are now in power in Greece and Italy. It seems that the Euro may be steadying somewhat and we'll now see whether this latest stabilisation of the Euro can last more than a few days.

Back on the markets I've been looking carefully at the triangles forming on ES and TF last night and this morning. These symmetrical triangles are continuation patterns 54% of the time and are also significant in Elliot Wave terms. Here is the model triangle from an EW perspective in both uptrends and downtrends:

Now let's compare that with the symmetrical triangle on ES, which I have marked up on the same basis. The wave 5 target would need to be no more than about 100 points long to avoid being longer than wave 3:

A similar picture on TF with a better defined wave 2. I gave 750 as the obvious target for TF on Friday morning and it reversed there almost exactly. I gave that target as triangle resistance looking at the symmetrical triangle and here is the TF symmetrical triangle also marked up as an EW wave 4 continuation triangle:

There's no equivalent on NQ, just a consolidation range that NQ has been trading within. That could be a rectangle though it's a bit sloppy. If it is a (68% bullish) rectangle any retracement should hold 2280 support on an hourly close basis and the upside target would be 2520, which would be a new high for 2011 of course:

I've been looking at GBPUSD as a proxy of the health of the anti-USD trade. That spiked up from the diamond bottom I showed on Friday morning to retest the lower trendline of the broken rising channel. This might fall hard from here, but the dominant pattern at the moment is a mildly bullish falling wedge. On a break below the 1.584 area with conviction this setup would turn bearish:

On the bigger picture there's still a nice looking HS pattern forming on GBPUSD, but the right shoulder may well not have topped out yet and might take another few weeks to do so. EURUSD breaking the declining channel on Friday looked encouraging for strength on EURUSD and GBPUSD for another few weeks until the next phase in the Euro crisis has had time to mature:

There are a couple of charts still casting doubt on this fairly bullish setup over the next few weeks. The first is the Vix IHS which is still in play. I won't post that today as space is limited and the setup hasn't really altered from the setup on Friday's post. The other is on 30yr treasury futures (ZB) where there is now a strong case that either a rectangle or ascending triangle has been forming in recent days. Both are about 70% bullish which would lean bearish for equities here. We'll see how that goes but a break with confidence over the last two highs would look very bullish for ZB now. Obviously a conviction break below 140 would look very bearish:

So there we have it. On the ES and TF setups I'm looking for a retracement to the 1225-30 and 712-15 areas respectively and that move may complete a triangle wave 4 on both, after which I would expect another wave up to a maximum of 1325-1330 on ES and to a maximum of the 800-805 area on TF. If we see that, it would complete a classic EW wave structure. A break below the symmetrical triangles with conviction would trash that EW count and point downwards much further, though I would add that symmetrical triangles have a nasty habit of breaking out in one direction before resolving strongly in the other, so I'd still advise some caution if the down move overshoots. A lower low on ES below the last low at 1218.5 would say to me that bulls should run for cover.