Euro Game Changer?

Euro Game Changer? (6/30)

Courtesy of Springheel Jack of Channels and Patterns

With the close just over the 100 daily moving average (DMA) on SPX, and just under the current rally high from the June low, there are now three main possibilities for the S&P 500 from a TA perspective:

  1. SPX tops out here and very soon, creating a double-top from the June low with a target back at that low.
  2. SPX makes it to the inverted head and shoulders pattern target in the 1403-5 area, topping out somewhere in the 1400-1445 range to make a much larger double-top with a target slightly above the October 2011 low.
  3. SPX makes new highs, breaks with confidence over the 1442 area pivot resistance and rises to test the 2007 highs over 1500.

Of these possibilities, the first now looks unlikely. I’m favoring the second option slightly over the third option, which was brought back from the dead by the EU Summit on Thursday and Friday. Here’s the SPX chart, with a healthy looking uptrend support trendline and with the close over the last of the key DMAs on Friday (click on charts to enlarge):

So what changed at the EU summit? Well the big debate there was whether Germany would be forced through intense peer pressure to guarantee much of the debt of its  insolvent neighbors through Eurobonds. Most of Europe is in favor of the bonds, while the Germans are adamantly against the idea. To avoid Eurobonds, it appears that the Germans have agreed, as a lesser evil, to relax the restrictions on the ECB assisting troubled EU sovereigns.

It’s hard to overstate the possible importance of this concession by the Germans. It opens the path to potentially huge quantitative easing by the ECB, something that had previously been ruled out by German opposition. We could see the ECB respond to problems in Greek, Spanish and Italian bonds by printing enough money to buy all of those troubled bonds. Does that sound unrealistic? In terms of overall Euro-area debt outstanding, such a move would only bring the ECB roughly into line with the Bank of England, held up as a model of caution in these strange looking-glass times. (But note, the ECB does not have the authority (yet) to simply print money, so the question of where is this money coming from is swirling around in the Financial Universe.)

How with the eurozone solve its problem with un-payable debt? Bruce Krasting argues that the most likely course for the EU is to devalue the Euro: “There is one currency option left. Devalue the Euro by 20++%. This would make a difference. It would go a long way towards stabilizing the real economies of Europe. It would create inflation, something that is sorely needed to devalue the real size of Europe’s debts. Germany would agree to this as it preserves their export-competitive position within the EU, and improves it outside of the EU. The technocrats in Brussels would love it; it’s the only thing left that would preserve the monetary union.

“Is this feasible? I say it is. It has happened twice before in history. In 1985 the world got the Plaza Accord that devalued the dollar and in 1987 we got the Louvre Accord that revalued the dollar. In both cases, the global central banks (CBs) and acted together. (Devalue the Euro)

It remains to be seen how far this concession will stretch, but this is definitely a potential game-changer, and could push any Euro crisis a year or two down the road, or more. Don’t buy any Euros however, as in the event that there is massive quantitative easing in Europe, that will effectively devalue the Euro in the same way that QE1 and QE2 devalued the US Dollar. The technical setup on EURUSD looks dire and this won’t improve the fundamentals. We might see the usual relationship between the Euro and equities invert, with equities rising as the Euro falls.

Here’s the technical setup on EURUSD, with the rising channel from 2001 broken and a possible H&S forming:

The prospects for the US Dollar looked golden before the EU summit, and the prospects for the Euro looked grim. That hasn’t changed. What may have changed is the prospects for equities, with what might effectively amount to QE3 coming from the ECB. We’ll see how that goes, but for the moment I’m treating equities as being in an uptrend until we see a break below the rising support trendline on my SPX chart above.

 

[Edited by Cycle Editing]

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