Is 10,500 a no go?

10,500 is like the land the Dow dare not close above.

It didn’t even matter that the unemployment count for November was far better then expected (a 11,000 drop). After starting the day up over 1%, the Dow Jones and the other two indexes both ended the day barely in the green.

The funny thing is that the good economic news actually contributed to the markets rough going. It all has to do with the complex and far reaching implications of an improving labor market and its effect on the dollar.

You see, most currency traders like to see an economy producing jobs. It makes them want to buy more of that currency, pushing the price higher.

The problem is, the dollar is being used to fuel a huge carry trade. If the value of the dollar  increases,  the carry trade becomes more expensive. Eventually any fund that is short dollars (borrowing) will have to unwind its carry trade (close out the loan and take a loss). And the dollar moves up, up, up.

This scenario is pretty much what happened today, albeit on a small scale. The November unemployment report came in strong, and some currency traders took that as a sign of strength for the buck. At the same time, the increase in the dollars value spooked carry traders into closing out their positions.

This drained liquidity from the global markets and resulted in all three major indexes closing at the lows of the day. Frankly, i’m shocked we didn’t close out deeply in the red.

Here’s the kicker…

If the market is weakening over employment numbers, how badly will it weaken once the Fed announces an end to its MBS purchases in the first quarter of 2010? How will the market react if the Fed raises rates by June 2010?Or the passage of FAS 167 in January 2010? All of these things are dollar bullish and should add downside pressure to the stock market throughout the year.

And on a finally note, let me show you a chat of the Dow Jones. It shows the important inflection point we now sit at.