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A Recipe for Disaster!
By Mike Conlon | May 7, 2010
With concerns over the Euro and the Greek debt crisis, yesterday’s market action became the “perfect storm” as there was a systematic breakdown in trading technology which sent the markets reeling. The Dow Jones Industrial Average dropped nearly 800 points in less than 10 minutes.
There were major moves in the currency market as well, as investors fled risky assets in favor of US bonds and the dollar. This helped contribute to what looked like a death spiral, as problems with trading technology caused some stocks to trade at erroneous levels, dragging the indexes lower and causing automated trading systems to take action which also exacerbated the problem.
There is still major risk in the marketplace; primarily coming from the Euro zone which some believe is fighting for survival. This morning, the German Parliament approved the Greek bailout, but the ECB still has a long way to go to figure out how to deal with contagion to the rest of the EU. Now the concern has turned to Spain, which may require a bailout as well as borrowing costs have increased dramatically thereby making it harder to service their debt. Unless a comprehensive plan is proposed, we could see continued problems for the Euro. The G-7 is having an emergency conference call to discuss a solution.
In addition, the UK elections took place and the result is the dreaded “hung Parliament”. However, Moody’s did not use this event to downgrade the UK credit rating, and the possibility exists that the government will be able to work together despite the political differences.
On what would normally be the biggest news of the day, the US Non-Farm Payrolls (NFP) report came out this morning and showed a gain of 290K jobs, which was better than expected. However, the unemployment rate ticked higher to 9.9%, showing signs that recovery is fragile.
In Canada, employment grew by 108K and the unemployment rate ticked down to 8.1% showing signs that recovery may be stronger than here in the US.
Lastly, the Yen is lower as the Bank of Japan pumped nearly 22 billion dollars of liquidity into its financial system in response to the Euro crisis.
In the forex market:
Aussie (AUD): The Aussie is higher this morning on yen weakness and is receiving support from a technical bounce as yesterday’s carnage sent the Aussie much lower. Right now there is a ton of risk in the market so at this point I’m not certain I would be looking to establish long trades here.
Loonie (CAD): The Loonie is the big winner today as better than expected employment numbers came in showing signs of economic recovery.
Kiwi (NZD): The Kiwi is trading on risk themes exclusively and getting a technical bounce similar to the Aussie. This is not to be confused with risk appetite, as this is more likely due to yen weakness and short-covering.
Euro (EUR): The Euro has bounced back from yesterday’s carnage as there is hope that the EU can come to some sort of a resolution on how to deal with the sovereign debt problems of its members. Today the first step was taken as German Parliament approved the Greek bailout, but now the larger looming issue of how to reduce borrowing costs for other nations experiencing similar problems is center-stage. They’re not out of the woods yet.
Pound (GBP): Fears of political gridlock due to the “hung Parliament” in the UK has sent the Pound lower, though the UK did manage to maintain its AAA credit rating from Moody’s. However, there is hope that what we are seeing from the EU will serve as a warning of what can happen in the UK if Parliament doesn’t work together.
Dollar (USD): The Dollar is mixed this morning as the NFP report came in better than expected but unemployment ticked higher. The Dollar is giving back some of yesterday’s gains from the flight to safety trade, but there is still major risk in the market.
Yen (JPY): The Yen is much lower this morning as the Bank of Japan added liquidity to the market to the tune of nearly 22 billion dollars. The Yen had major gains yesterday as carry trades we un-wound at break-neck speeds and demand for yen was high prompting this move from the BOJ.
In all my years of trading the markets, I have never quite seen anything like what took place yesterday. When technology fails, it can set off a chain reaction that affects every market. Due to the correlations between market instruments, a breakdown in one area can cause action in others and that’s exactly what took place.
Combine this with the uncertainty due to the risk coming from the Euro zone and you have the perfect recipe for disaster. With such extreme volatility in the markets, a lot of money can be made or lost very quickly. When situations like this arise, I advise to stay on the sidelines or only use risk capital that you are prepared to lose.
Until normalcy can return to the marketplace and confidence is restored, expect major volatility. Trade extremely cautiously if at all.
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