Yesterday, one of the big questions was if the now 7-session risk-on rally would continue to have momentum or could it show some signs of topping off?

S&P500 – Hourly Chart – Week Ends on Strong Action as Trend Holds, To Top or Not to Top…

When looking at the S&P the big question is whether this upward trend -that has shown itself so clearly over the last nine trading sessions – can extend higher, or will it see some type topping off and a move to correction. We saw signs of that on Thursday as we retreated from the 1213 area, and here on my chart we fell below our shorter-term moving averages and found support at the 100-period ema.  The bounce off that 100 moving average was a positive sign heading into today’s trading session. Overall, we saw a nice rally back to the week’s highs at 1213. As we move into next week that 1213 to 1215 area will be a crucial resistance level, especially if we look at the 4-hour chart of S&P 500.

S&P500 – 4H Chart – Laying out Some Scenarios

In the 4-hour chart we see that that 1215 area was important resistance in the middle of September. Here, we also see just how strong the recent rally was compared to the recent upswings the last 6 weeks. Overall we’ve had very choppy sideways action , and right now we are testing the upper levels of that range. That could be an important roadblock ahead for the index.

A break to the topside here would give the S&P index further momentum to move from the 50% Fibonacci retracement of the downswing from mid-July to early August to the 61.% retracement near the 1240.90 area.

However if prices retreat back below 1200, it could mean we see a more mature attempt for some consolidation. A break of the moving averages in the 1H timeframe, and a push and hold below the 21-ema in the 4-hour timeframe should mean either sideways action or a stronger attempt at retracement. We would draw a Fibonacci retracement from our low on Oct 4^th to our highs this week to follow any further correction.

EUR/USD – 4Hour Chart – Where Risk Sentiment Goes EUR/USD Goes

The same can be said of the EUR/USD which may target its 61.8% retracement in the 4H timeframe at the 1.40 level or it can falter here and bounced back down to the 200-ema back near 1.3650. If the S&P500 rallies to new highs, the EUR/USD is set to follow. However, as we get to the 61.8% level it’s important to know that that could be a place where traders would want to short the EUR on any negative developments.

Key Factors Next Week – Clock is Ticking on the Europeans & the US Macro Picture

1. Will the European Finally Get Their Act Together? In Europe we have seen some progress in the euro zone sovereign debt situation, which has helped spark this recent risk rally and move in the EUR/USD.

It started with talk of a coordinated bank recapitalization program, and over the last weekend Merkel and Sarkozy pledged to have such a plan by the end of the month. This week, after some theatrics, we saw the final member – Slovakia – approve the July 21 changes to the EFSF. It can now act as a buyer of periphery debt in the secondary market, provide aid to banks, and offer credit lines to sovereigns that may come under speculative attack. While so far the pronouncements by European leaders have helped to build a sense of optimism and hope in currency and in financial markets the details of any proposed bank recapitalization – as well as how to manage a Greek technical default – is sure to incur negative consequences on sentiment.

Outlines of a “Grand Solution”

The main contention is the opening up of the July 21 Summit agreement, in which private bondholders would write down Greek bonds by 21%. In light of recent events, Germany and others want a 50% write-down or more.

In order to do such a write-down Europeans will need to first set up support structures strong enough to stop the spread of contagion from a Greek managed. That will mean insulating the yields of other periphery countries under pressure. For a manged default, European will also have to have a credible plan to recapitalize the European banking sector.

The recent stress tests that were run over the summer in Europe did not test for a Greek manage default and therefore the strain to European banking sector will still have plenty of uncertainty. Therefore a European wide, coordinated bank recapitalization plan is necessary for a solution in order to reassure financial markets.

Putting the pieces together, this sounds a lot like the leaked agreement we had heard talked about following the G-20 meeting in early October:

• a Greek manage default with 50% write-downs,
• a European bank recapitalization plan,
• and ring-fencing countries periphery countries from contagion of a Greek default.

All Eyes on European Summit and G-20 Meeting

The Europeans have given themselves till the end of this month to figure out a grand solution that incorporates these three key elements. On October 24, the EU financial heads meets to hash out the details, and then on November 4 we have a G-20 summit meeting where the Europeans will present the plan to the rest of the world’s leaders.

The anticipation and speculation around these two meetings will be paramount for the direction of risk sentiment and where out risk rally goes from here.

2. Does Brighter US Macro Picture Extend into Next Week – While hope and optimism around a grand solution for the European sovereign debt crisis helped spark this risk appetite rally back on October 4, this past week the strong move towards further risk appetite was helped along by data from the US economy. Last Friday we saw the non-farm payroll report come in stronger-than-expected, posting a 103K reading and an upward revision to the 3 previous months of 99K. The report helped to calm some of the concerns that the US economy was careening back to either flat or negative growth.

Following a stronger jobs report, it was good to see that the US consumer went out and spend quite strongly (relatively speaking) last month – a headline gain of 1.1%. While the main chunk of that increase was better auto sales, the core retail sales reading was also strong at 0.6%. While US consumers may be more  pessimistic they are at least still spending. Better spending means forecasters will revise up their forecast for US GDP for the fourth quarter. Dow Jones News reports Barclays Ups its 3Q GDP estimate to 2.5% from 2.0%. Such upward revision to US growth is good for the overall global economy and therefore for risk sentiment.

Therefore we should keep a close eye on the upcoming fundamental docket in the US to tell us more clues about the economy. Next week is full of US releases. We will get reports on the manufacturing sector (Empire manufacturing index, Philadelphia fed index, industrial production), inflation (consumer and producer prices), as well as housing (starts, building permits, existing home sales).

These releases, along with a busy earnings season schedule should dominate US equities and the S&P.

Good trading.

- Nick Nasad is the Chief Market Analyst at FXTimes – provider of Forex News, Analysis, Education, Videos, Charts, and other trading resources.

Information and opinions contained in this report are for educational purposes only and do not constitute an investment advice. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness. FXTimes will not accept liability for any loss of profit or damage which may arise directly, indirectly or consequently from use of or reliance on the trading set-ups or any accompanying chart analysis.