Euro Opens with a Gap Down

Clearly the debt negotiations in Greece which are somewhat opaque at the moment, coming just a day (really hours) before the Euro financial summit are causing the market a lot of worry. This is an extremely complicated situation with multiple bond holder protection laws coming in to play, both Greek and UK.

Greece needs to get a high participation rate to make the debt restructuring plausible, to get the next Troika bailout tranche before their March coupon comes due, which if not paid will cause an all out default. If the Private Sector Involvement on the debt restructuring isn't seen as voluntary, that could and most likely would trigger CDS.

The latest in the the Greek drama is that the IIF (who s representing private debt holders) has said that the holder of Greek Debt have made their maximum offer regarding how much of a loss/haircut they are willing to take. If this is not seen as doable by Greece or if there are enough holdouts, Greece could introduce CACs, "Collective Action Clauses" that are retractive, which would certainly cause the restructuring to be seen as involuntary. The other issue is the ECB's holding's (as the largest holder of Greek debt) and the ECB's position in which it is loathe to accept losses on their Greek debt holdings. Specific clauses could be created to shield the ECB and to some extent, the IMF from taking the PSI losses, but this would set up a bond market that has senior and subordinated bonds and would do an incredible amount of damage to future bond holdings and auctions as the bond holder protections that have been in force of nearly 60 years would be thrown out the window and Portugal, Ireland, Spain and Italy, would certainly look to sabotage their economy to get the same treatment Greece received. Without getting in to all the details, the bottom line would be this, as a bond buyer, would you buy debt that you knew had no protections built in and that you would be likely to take a 50% or more loss on the bond because of a precedent set in Greece? Not only would auctions fail left and right, but current holdings would be liquidated as fast as possible sending all sovereign yields through the roof.

Again, the bottom line is the clock is ticking and Greece is between a rock and a very hard place. It seems almost any direction they take will lead to legal action from all corners. Even Germany has issues as well as the ECB with the Lisbon Treaty.

As I have stated before, late Friday ramps like we saw last week, coming on no news and no evident correlation, seem to me to be a way to lock in long and momentum traders over a weekend that they may otherwise be inclined to sell in to. This sets up a nice bull trap on a Monday gap down which would almost certainly create a negative snow ball effect.

  Here's Friday's late day ramp, note there was no legacy FX correlation that caused it as the Euro (red) did not participate.

The IIF stating that the private bond holders (many of which are hedge funds recently) have made their final offer, it doesn't sound like a breakthrough in negotiations, but rather a line in the sand that may create another walk out and break down in negotiations as we saw a little over a week ago.

As is always the case, it's not the news, but the market's reaction to the news, and thus far very early indications have not been positive, here are some charts of the opening of the FX market and specifically the EUR/USD in which the Euro has gapped down...

 Here's tonight's open on a 5 min chart, a move from Friday's close at $1.2933 to an open of $1.2887 (currently moving back down at $1.2885). Of course this is very early and the EU open is still 7.5 hours away so a lot can still happen overnight, however this is in line with what long term and recent short term 3C signals have been implying as well as the SKEW Index and VIX.

To get a feel of the open within a longer perspective, the open is below a neckline trendline of a recent topping pattern seen in the red box.

As you would expect, the E-mini futures have been hit pretty hard on the open as well.

ES closed Friday at $1311.25 and opened tonight at $1307.50 (currently $1306.50).

As we identified last week, crude continues to face strong headwinds with the FX correlation taking a toll.

As you know, despite geo-political events centering around Iran, I have maintained the model portfolio longer term short positions in oil open as 3C has been showing negative signals that have run counter to common sense re: the geo-politial concerns. Here is the recent action from last week in crude/USO.

 Here's a 15 minute chart of the bear flag in USO, normally we'd look for a head fake move before this bearish consolidation/continuation pattern resumed to the downside, but the crude market is nowhere near as easy to manipulate due to its sheer size as equities are. You can see the break below the bear flag at the red arrow.

 On a daily chart, the bear flag is in red, but there have been long standing obvious problems in crude as it has been in a 2+ month trading range.

 Here on USO's 15 min 3C chart, this is what we saw, the breakdown causing the flag pole decline as 3C went negatively divergent at the jan. 12 gap up opening highs, 3C didn't confirm and instead indicated distribution of the gap, which sent USO down. A small positive divergence (white arrow) formed the bear flag portion, which saw a negative divergence on Jan 19 gap up opening. The flag was broken to the downside later that day and resumed the next leg down.

As of tonight, the Light Sweet Crude Futures  have opened down from a close of $98.28 on Friday to tonight's lows of $97.40. Remember on Friday we also noted other commodity negative divergences, actually as early as Thursday when I warned about the copper company FCX which was underperforming all day despite a lower dollar. JJC also was showing negative divergences.

You didn't even need 3C signals on this one as it underperformed despite a weak dollar, the volume was large and looked like churning as there was little price movement, Friday confirmed with a bearish close near the lows of the day.

Here's the 3C chart.

Distribution was already evident at the first red arrow, the second red arrow was even worse as FCX was sold off hard as it made a new intraday high (white box) at the second red arrow. The red box around 3C is a more powerful leading negative divergence.

While our own Credit/Risk Asset vs. Equities models won't be available until the New York open, we can get a quick and dirty look at CONTEXT even though many credit/rate markets are not open yet.

While ES is moving down (red), CONTEXT's model is quite a bit lower implying ES is still quite rich compared to the implied correlation. This, among many other reasons, such as the SKEW Index, VIX, our own credit models , long term 3C indications as well as short term, and most recently very negative and very dominant Price/Volume relations , all led me to say several times last week, especially later in the week, that the "market looks to be in a very dangerous area here".

I'm going to have some dinner and take a look at a few other things in the market, if anything interesting pops up, I'll post it.

Have a great week!