For several months, I was harping on the fact that rates were headed lower and the US dollar was headed higher – which, in turn, meant that risk assets were likely to be under pressure. Once the projected targets were hit (on the downside for the euro, upside for the DXY, and downside for Treasury rates), I turned my attention to potential targets in the opposite direction (higher in the euro, lower in the DXY, and higher in rates). The first of the technical levels in the euro / US dollar cross and the US Dollar Index have been conquered, which tells me that there’s more to come on the upside for risk assets in the short-term.
The euro / US dollar cross has now crossed and closed above its first Fibonacci resistance and should continue higher from here.
The euro / US dollar cross (EURUSD) bottomed out in late July at around 1.204 and has bounced nicely off of that level. Based on my work, EURUSD appears to be in a wave (ii) correction to the upside, which could theoretically take the cross all the way up to the wave ii peak (see February peak on the chart). While that is possible in theory, I would not necessarily assign a high probability to that actually occurring.
Instead, I’m thinking that the EURUSD will make its way up to one of the next few Fibonacci retracement levels. The next levels of resistance come at the 38.2%, 50%, and 61.8% retracement levels, which equate to 1.25832, 1.27634, and 1.28340 on a price basis respectively.
A move to any of those three levels almost certainly will correspond with continued upside in stocks globally, but a move to the second or third levels or resistance will make buying in at current levels really worthwhile (if you haven’t already established your full positions on the long side).
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The US Dollar Index confirms what we’re seeing in the EURUSD.
The US Dollar Index is acting very similarly to the EURUSD in the opposite direction. I’ve actually updated / corrected the wave count on the chart based on me taking another look at things recently. The recent peak in the DXY was still the end of a short-term five wave sequence (wave ((v ))). However, the peak also represented the end of wave (i) higher (instead of the wave (iv) that I had assigned it in recent weeks). Why is that important? Because second waves have a much greater chance (typically) of being a deep correction of the previous wave than fourth waves. In this case, it means that we should look for a relatively deep retracement of wave (i) during this wave (ii) move – at least a 38.2% retracement, to be more precise.
Now that the DXY has already taken out its 23.6% retracement line, we must watch for a move down to the 38.2% level and observe the trading action in the DXY once that level is approached / tested. In price terms, the DXY should move at least down to the 81.81 level before we need to really be concerned about a turnaround to the upside.
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The message from the currency markets is pretty clear: Expect more upside for risk assets in the short-term while the euro and the US dollar make their way to the next technical levels of importance.
Treasury rates are starting to inch higher – despite the jaw-boning from the Fed.
The yield on the 10-year Treasury Note has progressed to the upside over the last week as money has flowed out of safety-oriented assets and into risk assets. My call remains for rates to move to around 1.949% on the upside over the short to intermediate-term. That leaves plenty of upside for those looking to fade bond prices. Do that at your own risk, though; the Fed is out in the media trying to talk rates lower in an effort to further stimulate the economy. It has succeeded in doing so for quite some time now. The question that arises now is, “If the economy continues to be relatively unresponsive, when will their dovish efforts be recognized as “pushing on a string”?
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Does the outlook for stocks mesh with what the currency and bond markets are telling us?
The chart below shows the S&P e-Mini futures (@ES) on a weekly basis going back to late 2006. The wave count I’ve drawn on this chart represents the most bearish of the possible wave counts I tried. You’ll notice that the minis appear to be in wave v of 3 higher with an upside target of 1,451 or so. That number can stretch out to 1,460 or so if we use closing levels instead of intra-bar levels. From 1,395, that’s a nice little bit of upside left in the current move – and this is the most bearish I can be at this time.
Once that level / range is tested, then we should see a consolidation / correction, but nothing too severe. The ultimate upside target in this bearish scenario is the 100% Fibonacci price projection line for wave C of the macro ABC correction (A was in May 2010 and B was the flash crash low) at around 1,515 or so. That approximate target level corresponds well with the 2007 highs (see yellow boxes).
This outlook for higher prices definitely meshes with the outlook for a higher euro, lower DXY, and higher Treasury yields. As Todd always reminds us, though, technicals are a good background for formulating decisions, but should not be relied upon exclusively. So, use my and all analysis presented here on the ‘Ville appropriately!
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With the break of the first technical levels in the currency markets, my continued outlook for higher Treasury rates and the apparent “room to run” on the upside for the S&P 500 futures, we must be ready to take advantage of continued positive action in risk assets. That means we need to have cash ready to buy any dips that occur in the short-term. If you’re already long of risk assets, hold on for awhile longer.
Before I wrap up, here’s a check up on the key European sovereign debt yields:
Rates in Europe have continued to come down as the very bearish trade that existed prior to Draghi’s and Merkel’s word play continues to unwind. I would like to attribute the recent move in the right direction to true bullishness on the prospects “over there,” but it just seems a bit far-fetched for everything to be fixed after one speech by Draghi and one reaction by Merkel. Considering how long it took to make those problems come to fruition, it usually takes awhile for the solutions to take hold. Regardless of the reasons for the move, the fact that the move is occurring is the most important thing to consider. As was pointed out in the currencies section of today’s report, all indications are that the recent bullish action should continue for a bit longer. All we can do is check the action at the critical technical levels.
That’s it for now! Have a great week!
No positions in stocks mentioned.
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