Evaluating True Upside With Currency Markets Bullish and Bonds Bearish

By Tim Thielen  AUG 20, 2012 11:15 AM

Currency markets are saying, "I think I can" while the bond markets are casting some reasonable doubts as to the staying power of this rally in the short-term. Here's how to measure potential.


MINYANVILLE ORIGINAL Several weeks ago, I indicated that there should be a rally in the euro, a sell-off in the US Dollar Index, and an accompanying rally in risk assets.  I actually gave projected targets for the various moves.  So far, only the DXY and stocks are successfully approaching their targets. 

The euro / US dollar is having a hard time progressing through initial resistance and there are some minor warning signs coming from the bond markets. Just as I noted last week, the crosswinds being observed in the various asset classes are making it tough to take a high conviction stance towards anything.

We continue to play the waiting game with the EURUSD.

I noted in the opening headlines that the currency markets are saying, “I think I can.”  Evidence of that can be seen in the euro / US Dollar currency cross (EURUSD) where there certainly seems to be room for the cross to move higher – even as this is a correction scenario.  However, so far the 23.6% retracement level has continued to act as stubborn resistance for the cross.  Interestingly, stocks and certain commodities have continued to progress higher despite the fact that the EURUSD has churned below resistance.  Is the action in the DXY mirroring what we’re seeing in the EURUSD?

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The US Dollar Index is shown below.  Clearly, the DXY has made it past the 23.6% retracement level and has as its next support the 38.2% level at around 81.81 (from Friday’s close at 82.51).  That level also corresponds nicely with the 100% Fibonacci projection line for what appears to be an “abc” correction (that level actually comes in at 81.78).  So there certainly appears to be room for the dollar to move a bit lower just as there appears to be room for the euro to move higher.  Both of those would tend to point to higher risk asset prices. 

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The Aussie dollar / Japanese yen cross is telling a similar story to the EURUSD and the DXY.

Moving away from the euro and the US dollar for a moment, let’s take a quick look at one of the other key gauges of global risk appetite: The Australian dollar / Japanese yen currency cross (AUDJPY).  The daily chart of AUDJPY is shown below going back to Q4 of last year.  In the bigger picture, I still believe the AUDJPY should work lower (to below 72).  However, in the short-term, the AUDJPY appears to be going through an “abc” correction to the upside with a target for wave “c” of 86.076 (from Sunday night’s level of 83.090). 

Just as with the scenario of a higher euro / lower DXY, a higher AUDJPY should spell higher prices for risk assets in general and commodities prices in particular. 

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Aching to try something new?  How about heading south of the border to Mexico?

My former partner at ThirdWave Markets David Weigman has been urging me to take a look at what’s going on with the chart of  the iShares MSCI Mexico ETF (EWW) for a while now.  I did look at it and have been continuing to follow it for months now, waiting for it to break out above some key technical resistance.  Today, I decided to take a look at what is going on from the currency perspective and how that may be influencing the equity trade. 

The chart below shows the US dollar / Mexican peso currency cross (USDMXN) on a daily basis going back to Q4 2011.  At first glance, it is obvious that there is an inverse relationship between the cross and the Mexican equities.  When the USDMXN goes down (US dollar weakness), Mexican equities rise.  The opposite holds true for when the US dollar strengthens against the peso (USDMXN rises). 

Recently, USDMXN has been on a fairly steady decline and has actually breached its long-term uptrend line (going back to 2009).  The cross does have some horizontal line support just below current levels, but the first thing I think when I look at the chart is that USDMXN is itching to go lower and the EWW is itching to go higher.  The trick is to remain disciplined and wait for the breaks to occur, or you will have a greater chance of top-ticking the EWW trade.

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Here’s a monthly look at the EWW.  This gives us a better look at the downtrend line resistance the EWW faces.

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The daily chart of the yield on the 10-year US Treasury Note ($TNX.X) is shown below.  As I mentioned last week, I thought that TNX would run into some short-term resistance at around 1.825%.  Well, during last week’s trading, TNX actually hit and surpassed that resistance level for a day or so.  Now, however, yields are back down below resistance and may be setting up for a short-term correction to the downside. 

My ultimate target for the bigger picture correction is still at around the 1.949% level on the 10-year T-Note.  However, before we see yields go up there, we’ll likely see a give back of some of the recent upside.  Such a move lower in rates would probably be wave “b” of an “abc” correction higher.  If you’re short of bond prices right now, get ready for a little give back of some of your recent gains.  If you’re not yet short of bonds, I for one would be waiting for a pullback to around the 1.48% level in rates to enter my trades (likely using TBT for that one).

If you’re thinking of going long of bonds (in terms of price), you can do so.  I would caution you to not overstay your welcome once the downside target in yields is approached as I’m expecting another sharp short-term rise in rates once wave “b” plays out.

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Emerging Markets Bonds are “0 for 2” in terms of holding support in the short-term.

The iShares JPMorgan US Dollar Emerging Market Bond ETF (EMB) has been featured here several times over the recent months, mostly because of how bullish it was trading.   It had been either holding support at the 14-day moving average or at its intermediate-term uptrend line – or both.  Now, however, EMB has broken down below the moving average support and the uptrend line support. 

The only hope the bulls have right now is that this is just a correction lower.  If that’s the case, then the “correction” support at the 100% Fibonacci price projection line should hold up at 116.90.  That’s not much of a move lower from Friday’s close of $117.74.  Even if you’re not scared off by the likely move lower to that support level, you probably will be scared of the downside move that will occur if that support level breaks.  Watch that carefully if you’re involved with this trade.

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If you couple these slightly bearish developments in EMB with the likelihood of a short-term decline in the US Treasury Note yield, the message from the bond markets seems to be one of caution for risk bulls.  That is a little bit in contrast to the hopeful signs coming from the currency markets.  Remember, though, that several of those currency messages are: “There’s room to go higher if xyz technical target is taken out.” Obviously, a lot will hinge on whether we see more upside in the euro and downside in the US dollar. 
Before I wrap up, here’s a check up on the key European sovereign debt yields:

All of the yields came down week over week in the key European sovereign markets I follow here.  That seems to be good news for European stocks which have been rallying.  However, why are we not seeing more of a rally in the EURUSD?  Just asking...

That’s it for now!  Have a great week!

Twitter: @tttechnalytics

No positions in stocks mentioned.

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