At the beginning of the week, I gave my opinions on stocks crashing or pulling back. My thoughts were that this is a pullback. The key point was that there is nowhere to go for real yield, and stocks will continue to be propped by cheap money by central banks. This past week we had the Bank of Canada, and just this morning, the European Central Bank give us an update on their policies. Want to take a guess at what they said? Before we delve into that, take a look at the daily and 4 hour charts of the S&P 500.
On Tuesday, the S&P 500 did break and close below a major support zone. Over on our Discord Trading Room, I mentioned I was a bit worried by this, however the Nasdaq and the Dow HELD their support zones, and we had other signs from the VIX, the 10 year yield and EURAUD indicating money was still going to flow into stocks.
We did have a green day yesterday, and what I was watching for, was a daily close back ABOVE the zone (which is now resistance-price ceiling). The close ended with a tease. The candle body did not close above my zone, but closed in an ambiguous way. To me it is not enough to say that this was a fake out or a trap (where traders are “trapped” as they chase the down move thinking markets will sell off, only to reverse it on them so they are forced to close, and markets then resume the opposite move).
This means that today’s daily candle close will give us more clarity and confirmation on whether this is a fake out with a close above this zone. Long term charts give us better signs on the overall trend, so the longer the timeframe, the stronger the signal. We do want to see this close above. However, on the 4 hour we do have something else playing out…
Over on our Discord Trading Room, I mentioned how I wanted to see a reversal pattern form. My favourite is the head and shoulders pattern. Just applying simple market structure, our lower high or swing comes in at the 3437 zone. These swings can be seen clearly in the downtrend where price sells off after popping higher. Remember, as long as we remain BELOW the previous lower high, we are still in a downtrend. So we do want to see this zone break.
Initially, I wanted to see price move up to 3437, and then sell off, before pulling straight back up to form a right shoulder in a head and shoulder pattern. But instead, we sold off back to the support zone, before pulling back. Take note of the large green candle at support. This indicates the buyers are defending this zone.
What we have now is a slanted variation of a head and shoulders pattern, with the neckline drawn out in the image. We are testing that neckline currently, and what we want to see is a 4 hour candle close above this zone, which we will not see until 10:00 am PST when we get a 4 hour close.
So in summary: we want to see the daily candle close above this zone today, a head and shoulders neckline break on the 4 hour, and hopefully, that break also coincides with a break above the previous lower high at 3437. All of this would indicate a reversal and the end of this downtrend/ pullback.
Onto the Central Banks as promised. You can probably guess what the Bank of Canada and the European Central Bank said.
The Bank of Canada, did not surprise and kept interest rates unchanged. But what matters is hints about where the policy is going. Many economic analysts believe that central banks can still ease and talk about normalizing rates. You all know my opinion: interest rates cannot normalize. In fact, it is more likely rates will be cut into the negative in order to help service debt…especially from the policies which are still to come from the fiscal policy side.
“Monetary policy is working to support household spending and business investment by making borrowing more affordable.”
Translation? More cheap money for a long time. Need more confirmation of this?
“This QE program will continue until the recovery is well underway and will be calibrated to provide the monetary policy stimulus needed to support the recovery and achieve the inflation objective.”
Central banks suppress interest rates by buying bonds, which lowers interest rates in a process called Quantitative Easing (QE). The Bank of Canada currently buys $5 Billion a week, and has no plans to wind this down…in fact, the number is likely to go up.
Madame Lagarde was on tap today for the European Central Bank (ECB), with many expecting a potential policy surprise because the Euro needed to be weakened. This did not happen. The ECB left rates unchanged, and kept their coronavirus-stimulus program unchanged.
The ECB’s Pandemic Emergency Purchase Programme (PEPP) remains at 1.35 Trillion Euros. This was ramped up in June from 750 Billion Euros to the current number, with plans for this to last until June 2021.
Lagarde said today that:
“Certainly under current circumstances, it is very likely that the full envelop of PEPP will be used,”
Analysts and market participants are now already pricing in an increase in PEPP by the end of the year, many eyeing December. Once again, more cheap money for a longer period of time.
Being a currency trader, the Euro has caught my attention. It is too high for the ECB which makes European exports less competitive due to the exchange rate. We are at levels not seen since May 2018.
Lagarde had something to say about the Euro:
The ECB’s mandate is to ensure price stability, however, big swings in the exchange rates could impact inflation.
As a result, Lagarde added that the ECB will “have to monitor carefully such matter.”
This means the ECB will be monitoring the exchange rate going forward.
Usually central banks weaken their currencies through rhetoric and forward guidance. Tell traders and the market what they want to do going forward, and the market prices in the currency move for the central bank. If this does not happen, central banks are forced to take much more aggressive actions such as cutting interest rates, or implementing QE. The ECB is already in negative rates, and their QE is massive. Their only ammunition, or tools in the toolbox going forward, is to cut interest rates deeper into the negative and/or increase their QE program. Take your pick.
This goes to the whole currency wars the world is in right now. Every central bank is racing to the bottom, trying to weaken their currency against the other. In the past, the US would take the hit. Allow the Dollar to remain strong, while other currencies weakened. However, the Trump administration has been vocal about a weaker Dollar. Now I am not saying the Fed is doing this on purpose, but they could potentially be weakening their currency to help emerging markets with high Dollar denominated debt and not enough foreign reserves (Turkey, Mexico, Chile, Indonesia, Argentina) stay afloat. Big emphasis on Turkey with what is going on in the country currently.