Wednesday, July 1, 2015

EDZ5; Market Tops Are Made When It Is Said 'You Can't Risk Selling'

We have been tracking EDZ5 with interest for a while.  In general, it has been my contention that EDZ5 has not priced enough Fed ‘normalization’ of policy.  We saw and reported several bearish technical developments (see here, here and here) and would point to a most recent development which cautions that volatility may pick up.  We have been additionally encouraged by the better than expected economic data filtering through over the last months. 

On Monday and Tuesday, EDZ5 formed 2 consecutive ‘doji’ patterns.  We offered a lengthy explanation about the insight we gain from a ‘double doji’ when we called a top in the Bund back in April (see: Bund Taking U-Turn at Zero Yield?).  In brief, a ‘double doji’ suggests increased volatility forthcoming. 


The EDZ5 ‘double doji’ was formed with consecutive open/close at 99.465.  It is interesting that this 99.465 level is the same as the triple top from mid-May.  Today, EDZ5 opened lower and may close a ‘bullish window’ that developed in the jump from Friday to Monday’s price action.  A ‘window’ closure would help to confirm the bearish implications of the failed bullish break-out and suggest further losses. 


The technical weakness combined with the potential for increased volatility bring a strong potential for a dramatic decline in EDZ5 and surrounding contracts that would imply a recognition of growth and inflation prospects that strongly suggest a more aggressive policy normalization plan than is currently priced.


Using a dull pencil and scratch pad we might construct a rough price for EDZ5 based on the Fed firming monetary policy in September and December:

Current 3 Month Libor
Addition to EDZ5 from Sep 25 bp hike
Addition to EDZ5 from Dec 25 bp hike
Implied EDZ5 price
Last EDZ5 price


As an Aside:  I heard someone on Monday say that you just couldn’t be short Eurodollars or Treasuries going into the employment report; that the risk associated with Greece was too large, no matter the nfp outcome.  Market tops are made when extraordinary circumstances dictate ‘you can’t risk selling’.   



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