Currencies and Bonds Are Painting a Short-Term Bullish Picture for Risk Assets

By Tim Thielen  SEP 04, 2012 9:25 AM

Technical breaks say jump on the risk train for a nice little ride higher in the short-term.


MINYANVILLE ORIGINAL Both the euro / US dollar cross (EURUSD) and the DXY (UUP) (UDN) are on the verge of technical breaks while bond yields should reverse back to the upside soon (which would likely only happen if risk assets are rallying).  If you see signs of those three things occurring, jump on the risk train for a nice little ride higher in the short-term. Below are the specific targets along with outlooks on the Aussie dollar and bonds.  

The EURUSD is trying once again to break through the near-term ceiling that has formed.

The euro / US dollar cross  is attempting once again to break out above the 38.2% Fibonacci retracement (of wave (i)).  If it succeeds this time around, the next resistance level would be the 50% retracement line at 1.27731.  You can be sure that a breakout above resistance would spur on more of a rally from the rest of risk assets.

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The action in the DXY is confirming what we’re seeing in the EURUSD.

Obviously as the EURUSD is threatening to break out above resistance, we would expect the DXY to be on the verge of breaking down below support – and it is.  The 81.09 level on the DXY represents the 50% retracement line (of wave (i)) support and is now starting to show signs of breaking.  A convincing close below 81.09 would open up more downside potential for the DXY in the short-term.  The next target would be the 61.8% retracement line at 80.39. 

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The macro picture in the Aussie dollar looks bearish – use any short-term bounce to resistance to play the short side.

Now that I’ve covered the requisite euro and US dollar charts, I would like to touch on some of the other happenings in currency land.   One of the currencies that act as a key gauge of risk appetite is the Aussie dollar.  I’ve been noticing some developing weakness in the Aussie currency and wanted to take some time to explore if what we are seeing is corrective in nature or something more serious on the downside. 

The first chart below shows the Aussie dollar / Canadian dollar currency cross on a monthly basis going back to 2007.  I’m seeing what looks like an “ABC” correction higher.  I know it doesn’t look like it on the chart, but the low that was made in early 2001 was the end of a massive downtrend that began way back in 1974.  So, at this point, with the C wave on the chart peaking right at the 100% Fibonacci price projection level (1.10819), it could spell real trouble for the cross (meaning real weakness in the Aussie currency versus the US dollar).  These are the things that I would need to see happen to force me to change my bearish view on the AUDUSD:

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If those items do not become a reality – and soon – then the likelihood is that the AUDUSD is in for major downside over the coming years. The major sign of this bearish case becoming the reality would be for the 100% Fibonacci price projection line (see blue Fibonacci lines) on the downside to be broken.  That level of support comes in at .91265.  Before that breakdown would occur, we would get a yellow flag in the form of a breakdown below the lower edge of the aforementioned pennant formation, which would come in at around 0.97000. 

So do I really think all of that will happen with the AUDUSD?  Let’s take a look at the daily chart next.  In the chart shown below, you can still see the red lines of the pennant formation as well as the blue 100% Fibonacci price projection line down at 0.91265.  What I’ve added here is the very short-term wave count (currently in wave (iii ) lower) and the corresponding Fibonacci lines.  Given the fact that the AUDUSD closed below the 100% Fibonacci line or “correction” support, it does appear to me that we’re going to see a continued move lower. 

We should see an eventual test of at least the lower edge of the pennant formation at 0.97 (at the very least).  If the macro bearish case mentioned above is the reality, then we will see not only a breakdown below the lower edge of the pennant, but also a test and break of the 100% Fibonacci line at 0.91265.

Given the fact that we’re starting to see the bearish case unfold, the task now becomes to determine where to enter on the short side of the trade.  As always, it would be ideal to sell short just as a short-term peak is being made.  Since we may see a rally in risk assets in the short-term (based on the potential currency moves outlined above), we may also see a bounce in the AUDUSD.  I will be looking to target the 1.04 level for new short entries – just be sure to stop yourself out on any close above that level.

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The 10-year Treasury Note may have another day or so of downside – but look for a bounce in yields soon.

In bond land, the yield on the 10-year US Treasury Note has continued to work its way lower toward my downside target of 1.482.  Bernanke’s Jackson Hole speech on Friday did little to de-rail this train.  Now, the question is whether it will stop at the expected station. 

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What will be interesting to see is whether these lower rates are really looked at as bearish signs / predictors.  If my recent take on yields is correct, then we may see another day or so of downside in yields, but then a sharp turn to the upside.  I’m thinking that if the potentially bullish developments in the charts of the EURUSD and DXY stick, then we will see Treasury yields move higher for the “c & iv” wave very soon – probably coincident with the currency moves.  The move higher from 1.482% to the upside target of 1.949% would only make sense if the equity markets still have another up leg left in the tank – so I guess that makes me short-term bullish on equities once rates bottom out at or near my target. 
Before I wrap up, here’s a check up on the key European sovereign debt yields:

The yields of both Italy and Spain have started to move back up over the last few days after pulling back nicely for the previous couple of weeks.  At this point, it’s too early to tell if this is more than a correction higher in yields.  All we can do is monitor the yields carefully to see if the typical signs of a sustained upside move present themselves (i.e., higher lows and higher highs).  Meantime, Portugal’s yields are on the move lower – so no worries there. 

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

Twitter: @tttechnalytics

No positions in stocks mentioned.

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