A Currency Crisis

I’m taking my time this Saturday afternoon to bring some events that I believe are very significant to your attention, perhaps you’ll have something to add as often members do.

Let me set the stage, it’s important to know what is “normal”, what is not, what we have seen on the horizon long before anyone imagined it and what has happened in a flash of a moment that may (I can’t see how it won’t) have severe consequences.

Lets start with the heart of the matter, in yesterday’s Leading Indicators post, I said the following with true concern…

And for the week, the USD pullback has been supportive of the market, but the last few days something hasn’t been right. I will look this weekend, but I suspect currencies are about to flip, the $USD back to its uptrend, the Yen moving higher and some others that won’t be good for risk assets like the SPX.”

You may recall the BOJ (Bank of Japan) policy statement at 10 p.m. on April 4th, they laid out the most ambitious QE plan ever attempted by a Central Bank. The Yen immediately dropped and I remember this very well because I spent the entire night and a good part of the early morning hours on April 5th monitoring the action, (when I felt safe that the situation was under control for the short term and felt safe it wouldn’t lead to a disaster in the market-the entire reason I stayed up until 4 a.m.). The last post was at 3:45 a.m. Friday April 5th, “Yen Looks to be Under Control… For Now” posted at 3:45 a.m. (I remember well because I slept the following Saturday and Sunday until 2 p.m. as that week was filled with days starting at 8 a.m. and finishing well past midnight and even 4 a.m.).

What had happened was 3C had clearly shown FX traders were going short the Yen in advance of the BOJ’s policy decision which was clearly going to be Ultra-Dovish and filled with QE as Japanese P.M. and his nominated pick to head the BOJ (Bank of Japan-Central Bank), Kuroda had been promising for months.

Here’s the immediate aftermath on a Yen chart posted Friday April 5th at 3:02 a.m. “Market Futures-After the (new) BOJ’s First Meeting, Did They Lose Control?”

This 5 min 3C chart of Yen single Currency Futures shows the negative divergence/distribution (likely short selling)  going on for hours before the BOJ’s policy decision, which is when the Yen fell sharply.

I stayed up late after seeing the initial response reverse and to make sure the policy decision hadn’t backfired as soon as it was announced, something that would have drastic effects on the market and something I needed to be on top of for you. The drop in the Yen was market supportive (although I had and still do, make clear that this would likely lead to conflict through trade wars and even open military conflict with China as the BOJ policy would send inflation higher in China and China is already fighting inflation by draining liquidity through repos and property curbs).

The problem was, only a few hours after the BOJ policy announcement, their 10-year JGB (bonds) plunged so fast that JGB futures on the Tokyo Exchange tripped a circuit breaker and trade was halted, yields soared, that’s around the same time the positive 3C divergence (accumulation) in the Yen chart above started moving Yen prices higher (bad for the carry trade and market), but the worst thing was, rising JGB Yields and falling prices were seen as the proof that Kuroda’s ambitious new QE policy had failed; this was a 2-year policy and in the first hours it seemed it had failed. 

I waited for almost another hour until I saw enough short term negative 3C divergences in the Yen itself (futures), that I was satisfied that the Bank of Japan had stepped in (intervention) to the market and propped things up, halting a stunning collapse.

That’s when I posted “Yen Looks to be Under Control… For Now” with the following 1 min 3C chart of the Yen

Remember the chart above this with the positive divergence is a stronger 5 min chart and prices started to move up, however this 1 min chart shows faster, newer action in the market, even though it’s not as strong, the negative 3C divergence in to the rise in the Yen convinced me the BOJ had halted the collapse for the time being and I posted the last post linked above at 3:45 a.m. Friday April 5, 2013. *The 5 min chart remained positive, that’s why I titled the post, ‘Yen looks to be under control…FOR NOW”. Over the following days, the JGB futures were halted due to massive decline 3 consecutive days on the Tokyo exchange, remember, this was to be the sign that Kuroda’s (Head of the BOJ) plan failed.

Here’s the U.S.Dollar Index forming what appears to be a large “W” base. I will not get in to the recent shift in one at the F_E_D re: QE as it has shifted from a time they would never talk about ending policy, only say that they had more tools and were standing ready to use them to a very open debate about ending policy with some regional president’s suggesting it could be tapered by summer and ended by year’s end, at least two F_E_D presidents of the Dallas F_E_D and Philly F_E_D said that last week, there have been numerous other documented incidents since QE3 was announce on September 13, 2013 that I have featured as the F_E_D first changed the yardstick and then talked more openly and has been doing what I call, “Slow boiling the frog”, rather than announce something drastic at once, preparing the market in smaller bits. I could write for hours just on the documented facts since September 13th, just suffice it to say the $USD would move higher, risk assets lower and it appears between that and the currency wars between G7 Central Banks, the $USD is already starting to discount that.

The $USD in green and the SPX in red on a 30 min chart shows the market has been moving up against the $USD, an unnatural correlation, but assets such as Treasuries (TLT), Volatility Futures (VXX) and High Yield Credit (HYG) have been used to manipulate the market higher to psychological areas that the market and participants want to see any way. However, since the yellow box the $USD and SPX have seemingly started to revert to their inverted or opposite relationship and the recent pullback in the $USD allowed the SPX to move to its new highs, I believe that $USD pullback is ending, but it’s in tandem with Yen action that really makes this an event to keep a close eye on as the USD/JPY is one of the popular carry trade pairs.

Why the Yen?

While the Yen seems a million miles away from anything relevant to the U.S. Stock market, you must understand how a lower Yen finances the carry trade that Institutional Investors use to leverage up their cash and buy risk assets) For a definition of the Carry Trade concept, see this link. Also in a world where all Central Banks are devaluing their currency in a currency war (as we have been seeing), the result as mentioned, tends to be the $USD gets bought (also not good for the market as the $USD and risk assets like commodities and stocks move opposite the $USD normally).

We can learn a lot about the market by paying attention to the current carry trade pairs as well as market fundamentals like market breadth. This is why I have followed the USD/JPY and EUR/JPY (two popular carry trades in which the Carry Trade leverage is used to purchase stocks that are higher yielding) and have spent so much time posting charts like these two (current) along with others for this very reason.

The carry trades like the daily EUR/JPY which I have dedicated so much time to following closely as there were subtle hints at first that the character of the trend was changing and as we know, “Changes in character precede changes in trend”. 

The carry trade is profitable as long as the pair (in this case and the EUR/JPY’s) is rising, which means the EUR is rising and/or the Yen is falling or falling faster than the Euro is rising. However these trades can be at 200:1 leverage, which is how Institutional investors leverage their AUM (Assets Under Management) to increase performance, but at the same time at that kind of leverage, even small moves against the FX carry can send the trade to sharp losses instantly. Leverage is always a 2-sided sword, but at this level, it’s a whole new concept in risk.

I noted the trend getting more volatile on the upside in orange,  although people often think these volatile gains are bullish, they often are the first sign of a top. In red the trend was broken, this is around the same time the market averages broke my Trend Channel, I said back then that, “When we look back a year from now, it will be that moment that is understood to have been the moment the back of the trend was broken”

Even though SPX prices are higher now, people can rarely separate price action from the clear signs of trouble; I have seen 2 months of upside price gains wiped out in a single day or gap down so these are very dangerous times to be long the market, yet people who read the headlines, “S&P makes all time new high”, can rarely see any further than the headline. When the reckoning comes, they stand to lose a greater sum so fast that there’s nothing they can do about it, yet the warnings were there the entire time for those who were attentive.

*Note the carry trade started on 11/12, several days before the market low was put in and the new up cycle began.

The USD/JPY carry trade also started as the market was still heading down, in ornage trade became more volatile than normal and in red it broke its trend, the slightly higher prices are very rarely worth pursuing as the volatility that comes after the break of the trend is often unpredictable and much larger than most can imagine.

So 1 piece of the puzzle is right above and you know I have been posting these charts at least 2-3 times a week for two months now as the first changes were noticed.

Lets add in another piece of the puzzle, the SPX trend…

This is my Trend Channel based on the Turtle Trader’s work, it is the first custom indicator I won an award for. Similar to Bollinger Bands, the Channel track’s each asset’s character and creates a channel based on Standard Deviations around it, when there’s a break of the channel, it’s usually a stop out and an effective one, it means something has significantly changed in the character of the trade by at least 2 SDs, that stop out came in late Feb. however as I have explained, the Channel will never take you out at the top and often there’s choppy volatile trade after, sometimes leading to new highs, but in the bigger picture, they often end badly with all gains being wiped out in a day or so, I’ve learned to trust the channel and let everything else take care of itself because I have seen the end results over nearly a decade.

***However, for my point, just note when the stop out/break of the Trend Channel occurred.

Now here’s the SPX trend, Point “A” is September 13, 2013 when QE3 was announced, this time the market didn’t shoot higher and member’s know what we discussed back then as well as the 3C signals. At “B” the SPX never made a higher high after some slight gains September 14th, from there the SPX traded sideways and then fell about 8% to the November 16th lows at “C”, the start of a new cycle and “D” is that cycle.

Now this is a breadth chart, I’ve posted these on average about once a week and I’ve posted about a dozen different ones, all  show the same thing at the same area. This particular breadth chart is Worden’s T2108, it is the “Percentage of ALL NYSE stocks trading above their 40-day simple moving average”.  As the market moves higher, breadth and volume should confirm a healthy move, however if we look at the SPX trend in green vs T2108 in red, we see something we see on
EVERY breadth chart we look at. These are actual numbers like an advance/decline line, they are not subjective, they are as objective as you can get.

At September 13 (QE3) 82% of all NYSE stocks were trading ABOVE their simple 40-day moving average. At the November 16th low, only 17% of NYSE stocks were trading above their 40-day moving average, it was a strong move in breadth to the downside. From there T2108 trended up with the SPX as it should at 68% in December, 85% in January and then around the time the Trend Channel was broken, the percentage of NYSE stocks above their 40day moving average fell to less than half at 48%.  On the recovery in March the percentage went back up to 64%. Even though the SPX was nearly 5% higher than January when breadth was at the high of 85%, the percentage of stocks holding their 40-day moving average had fallen to 64%, about a 25% decline in breadth! 

From there around April breadth made a new low at 46% even though again, SPX price was nearly 5% higher, more and more stocks were falling below their 40-day moving average, overall market performance judged objectively was failing in most of the market, yet a few heavily weighted stocks in the individual index weighting plus some manipulation such as the SPX not making a new high and being less than 2 points away from it’s all time new high for 3 trading weeks until the very last day of the quarter, April 30th and in front of a 3-day weekend when “New highs ” would be splashed across the news and just in time for new money to enter fund like 401k’s and IRA’s. Is that coincidence that for 3 weeks, we couldn’t move a fraction of a fraction of  percent until just before new prospectuses could be issued and the event plastered across the media?

Around our all time new SPX high, the percentage of stocks above their 40-day moving average is 65%, this is nearly 24% lower than the readings in January, yet the SPX is 6.75% higher with barely more than half of all NYSE stocks above their simple 40-day moving average. Some breadth readings are even worse.

This tells me a few things, the break in the Trend Channel coincided with serious deterioration in market breadth, something big really did happen there. The changes in character in the currencies and especially the Carry Trade currencies have changed character severely. Remember, to close the carry trade, typically the assets bought (stocks) have to be sold (look at market breadth with more and more stocks falling below their 40-day average) and the initial currency sold has to be re-bought, that’s the Yen.

The BOJ policy allowed the Yen to be covered or the carry trade closed at very favorable terms as the Yen was lower, look at the recent spike in the EUR/JPY and USD/JPY above the trend lines (the change in character is worrying enough). However as I started the idea for this post Friday saying,

And for the week, the USD pullback has been supportive of the market, but the last few days something hasn’t been right. I will look this weekend, but I suspect currencies are about to flip, the $USD back to its uptrend, the Yen moving higher and some others that won’t be good for risk assets like the SPX.”

Ever since that night on April 5th, 3C has been showing continuing accumulation in the Yen, here’s a look.

The first divergence is a strong relative divergence, in the white box, a stronger leading positive divergence. *Note this is not the 5 min chart that went positive on April 5th, this is a much stronger 30 min chart (meaning much bigger underlying flows) and the divergence is seen on an hourly, 4 hour, and even a daily chart!

As I was saying, I suspected something on Friday was about to change, it wasn’t until a few of our member traders emailed me that they were making lots of money in the Yen and Yen based pair FX trades that I noticed the Yen has started to move on Friday in the direction of the 3C accumulation.

Both carry trades fell as well…

USD/JPY on Friday

EUR/JPY on Friday as the Yen was rising.

Remember, a rising pair is supportive of the carry trade, a falling pair can be disastrous. Remember these charts and compare to the SPX’s trend (don’t forget the changes in character as well as volatile moves up seem good, but are often the last thing before a top/reversal-just look at tops and the trend preceding them)

EUR/JPY’s daily trend

USD/JPY’s Daily Trend…

I’m going to post this now and let you chew over it, I’ll post the rest of my findings later today…