Summers, Merkel And The Fed: What A Week!

This week was always going to be a tricky one for both traders and investors, with the market’s primary focus being the FOMC meeting on Wednesday -- the meeting at which the FED is likely to signal the beginning of the end of its bond-buying program.

At least that’s the theory. But given the less-than-stellar NFP data, it's far from certain.

Angela And Larry
This week also marks the run up to the German elections, as Angela Merkel tries to retain power for a third term. These two major events were always going to provide the main talking points for the markets this week, or at least they were, until the unexpected announcement on Sunday that Larry Summers had withdrawn from the race to be the next Chair of the Federal Reserve. This decision has resulted in a boost to equities, which have responded positively as Summers was always considered more of a ‘hawk’ in his attitude to reducing the FED’s QE program. As always it was the forex markets which reacted first and fastest, as risk currencies such as the Aussie Dollar opened gapped up and the Dollar Index fell below the all important 200 day moving average.

The next capital market to post its reaction to the Summers decision has been the bond market, where we have seen a pronounced fallen in the 10 year, and a minor pullback in the 30 year yields.


Moody Markets
However, as I often say, trading (and investing) are primarily about the identification and management of risk, which is why it is so important to keep a close eye on those markets and instruments that can reveal, in an instant, the market’s level of risk tolerance. Being able to gauge market mood and sentiment will not only reveal trading opportunities, but also give early warning signals of major reversals.

Of course, these market reactions may simply be temporary, and they do not relegate the significance of Wednesday’s FOMC meeting, which may yet produce some surprises. One such surprise may be a decision to postpone any tapering until some kind of resolution to the debt ceiling crisis in the US, which has re-emerged in the last few days.

However, it is the uncertain outcome of the German elections that may provide the biggest jolt to markets in general and the euro in particular.

Tough To Predict
The reason is straightforward and lies in the number of parties that make up Germany's political landscape. This makes trying to predict the outcome of any German government almost impossible as the incumbent Chancellor needs to horse trade and negotiate in order to form a working majority. The worst result for Angela Merkel would be a stalemate, and the need for further elections.

Viscious Short Squeezes
Such uncertainty could not have come at a worse time for the euro whose very existence continues to defy its critics and detractors. For perma euro bears, the last two years have been expensive as each attempt to sell the euro, particularly against the US dollar, resulted in ever more vicious short squeezes.

Euro Watch
Perma euro bears have also given us a master class in why having fixed and unwavering opinions about a market or instrument can be so destructive. In my book, A Three Dimensional Approach to Forex Trading, I discuss how, in its current construction, the euro cannot succeed as it is backed by neither fiscal nor political union, so as each euro crisis has arisen, euro bears short the single currency in an attempt to minister its last rites. However, this eagerness seems to blind them to the technical picture and the determination of the European elite to ensure the euro’s survival.

In its current format, the euro can't survive, but euro bears should not allow their prejudices or opinion to cloud their trading judgment. When trading, it is so easy to become emotionally involved with a market or instrument to the extent that it overwhelms judgment.

So it looks to be a fascinating week and, given the magnitude of the events unfolding, expect a bit of extremely volatility mixed with potentially profitable trading opportunities.