Return-Free Risk

I was amused this weekend to read again the wonderful phrase 'return-free risk' applied to sovereign bonds in Europe, which is a better description for sovereign bonds generally nowadays than the 'risk-free return' that used to describe these in days when interest rates were higher and government debts were lower.

The article (in The Economist) was talking about the latest European proposals to shoot the messenger on sovereign bonds, with restrictions on rating agency ratings changes for vulnerable sovereign issues, along with the usual attacks on short sellers and attempts to restrict the CDS market. Utter nonsense of course, and worrying for anyone who still thinks that governments in the Euro zone might have any idea either of what is happening, or what might usefully be done about it.The proposals might as well be designed to scare away any remaining potential buyers of Euro zone bonds and is characteristic of the arrogance and incompetence that we are used to seeing from central planners everywhere.

Nonetheless the outlook is looking promising this morning for a decent reversal back up from last weeks troughs on equities and the Euro. I was saying all last week that there was unlikely to be much of interest on the bull side on equities until 30yr Treasury futures (ZB) broke the strong rising support trendline there, and that was broken overnight on Thursday. On Friday morning I commented on twitter that an H&S had formed on ZB and that has played out to target overnight, finding some support at the important 142 support level:

That has delivered an impressive move up on ES, and at the time of writing that is suggesting that we might see a 30 point gap up on SPX. ES has recaptured the important support turned resistance level at 1180, and the next obvious target is the psychologically important 1200 level. That's also a potential IHS neckline, so I'll be watching any action at that level carefully:

This might well in my view be the start of a strong multi-day bounce. I've been reading a lot of analysts arguing for a bounce into the 1216-30 SPX level and for a nice chart on that possibility I'd suggest that you have a look at Serge Farra's chart at Stock & ETF Corner. You can see that here. Whether we bounce that far or not is heavily dependent in my view on what USD does here, so I'll be concentrating heavily on forex charts today.

First USD futures (DX). I've posted the DX chart a few times last week and I've been struggling a bit with the resistance trendline there. I had two candidate wedge upper trendlines, both of which broke up, and DX has reversed so far at the third option just below 80. I have the strong support trendline in the 78.8 area, and a break below that with confidence should open up a move to strong support in the 77.75 area. That would be a potential H&S neckline of course and might well then signal a larger reversal after a bounce there. Without a reversal on USD I suspect that any rally on equities will be short :

I think that support might well break on DX, and both GBPUSD and EURUSD are in promising looking bullish falling wedges that might well break up here. On EURUSD my spookily accurate EW chartist friend was suggesting a couple of weeks ago that the current move down should finish by 1.31, and that we should then see a strong C wave up from that low. When he made that forecast EURUSD was in the 1.38 area and the low so far is near the 1.32 level. In pattern terns EURUSD broke wedge support late last week and it looks as though that was an overthrow that would normally precede a break up. In the short term EURUSD looks as though it might be forming an IHS at the 1.34 level. If so I'd be looking for a pullback into the 1.332 area today to form the right shoulder:

There's another falling wedge on GBPUSD. Wedge resistance in the 1.56 has almost been reached overnight and GBP is pulling back from there at the moment. A break above 1.56 with confidence should be followed through and I'd be looking at the resistance levels at 1.569 and 1.59 there:

Oil has also bounced strongly overnight and I'm wondering whether it will retest the highs to make a double-top. The setup there is shown on the chart, and the action on oil in recent days is also an excellent example of why triangles can be tricky to play, as a small triangle formed on CL last week, broke down, and then resolved up hard

I'm leaning towards seeing a strong bounce on equities here. One reason is because my spookily accurate EW friend is expecting a wave up on EURUSD here, but the other is that the many huge H&S patterns forming on a number of indices and instruments all look a bit undercooked, with another few weeks needed to improve the symmetry of the right shoulders before they play out to the downside. A good representative example of those is the H&S forming on the EEM chart. This Emerging Markets ETF is something I often refer to as a useful leading indicator for SPX and if this H&S plays out, it would target a return to the March 2009 lows:

As for today the recent action on ES could be a bull flag, and if that plays out then we might well see a test of the 1200 level today. If we see some retracement then strong support is at 1180, and if that's broken we might see an attempt at filling the huge gap. I'd be surprised to see any retracement get much below 1170 ES.