New landscape on the horizon for economy

Last week has seen three important changes for financial markets. They change the behavior of commodities, alleviate currency pressures and signal the potential for a short-term boost in US economic activity.

The most important of these changes is the administrative decisions by the Commodity Futures Trading Commission (CFTC) to change the margin requirements across all commodities futures contracts. This is metals, soft commodities such as wheat and soybeans, and energy including oil and natural gas. On top of these they have also announced changes to the futures swaps conditions. Rules scheduled to take effect last July for the $601 trillion swaps market may now be delayed as long as a year

Tightening margin requirements mean that traders and speculators with open positions in commodity markets will face larger and more frequent margin calls. Many will not be able to meet these so there is a higher probability of a commodity sell-off.

More importantly the changes in the swap conditions go to the very heart of the investment speculation that has been significantly responsible for the prolonged increase in commodity prices over the past few years.

The oil market collapsed in 2007 when there was a rumor of potential changes to the swaps market - or closing what was called the swap loophole. The new changes confirm the ability to use the swaps loophole will be significantly reduced.

This means that it becomes more difficult for commodity investment funds - the Exchange Traded Commodity Funds - to hold long-term open positions in the market. Many will be forced to unwind long-term positions, expanding liquidity in the market and flooding the market with sell orders. This will not be sudden, but it will be accelerated by margin calls and regulation changes. The result is a decline in commodity prices as the speculative pressure is removed. For many countries that rely on commodities for growth it means financing economic growth becomes cheaper.

This CTFC decision is sure to be challenged in the courts so the effect of the changes will not be sudden.

The second important change is a continuation of a longer-term trend toward weakness in the US dollar. The US Dollar Index developed a symmetrical triangle. The breakout from this pattern was rapid and temporary. It was a rally driven by weakness in the eurozone. Investors had little choice but to go to deep and liquid markets and this meant US Treasuries. During this period China reduced its US Treasury exposure in favor of diversification into European debt and other instruments.

The US Dollar Index rally quickly lost momentum as it reached the symmetrical triangle pattern targets. The result is a return to the longer-term trend of dollar weakness. This suggests that the current weakness in the US Dollar Index has support near $0.745. This is just above the midpoint of the previous symmetrical triangle pattern. The depth of this pattern suggests there is a reasonable probability the US Dollar Index will fall below $0.745 and retest the lower edge of the base of the symmetrical triangle pattern near $0.725. Traders will look for a consolidation pattern to develop between $0.725 and $0.745.

The third factor is a breakout above the upper edge of the L-shaped consolidation pattern in the Dow. The Dow was dominated by a head-and-shoulders reversal pattern. The downside target near 10600 has been achieved. The upper edge of the L-shaped consolidation pattern is near 11600. The breakout from this pattern is signaled by a weekly close above 11600. This has developed. This signals a breakout move toward 12300 as an upside target.

It is important to note that this is not the beginning of a new upside long-term trend. This has the characteristics of a short-term rally.

These three changes - and in particular the changes to margin and swaps requirements - change the economic landscape in the short term, and in terms of commodities, in the longer term.

Although we do not expect to see an immediate effect, this signals a change in economic conditions.

The author is a well-known international financial technical analysis expert.