Risk Tells in the Currency and Bond Markets Pointing to Further Short-Term Downside

By Tim Thielen  SEP 26, 2012 4:10 PM

Expect a downtrend from now until October and then a rally into the end of the year.


MINYANVILLE ORIGINAL My go-to tells in the currency and bond markets are either starting to roll over or simply have much more downside to worth through before the short-term moves are over. The euro, the Aussie dollar, the US high-yield market, and emerging market debt are all showing signs that this pullback in risk assets will be more than just a few days in duration.


The 10-Year Treasury Note Yield didn’t get to test resistance (yet) before the current down move began.

I was calling for a move up to at least the 1.978% level on the 10-year US Treasury Note yield before I saw another down move beginning. As we all know, it’s tough sometimes to get the markets to do just as you predict. There still may be a little upside move in yields heading into the end of the month/quarter. However, at this point, nothing is a certainty. The macro picture in yields still tells me that the low yields from July will be tested – it’s just a question of whether that happens during this move or after one more shot to the upside.
The implication of lower yields – assuming recent relationships hold up – is that risk assets should remain under pressure. So, my call was for a rally in risk into month’s end (corresponding with higher yields), which would then be followed by the “risk off” trade taking back over in October (corresponding with yields falling to test the July lows).  It’s the first part of that prediction that is in question. The second half of the prediction seems to me to be almost a certainty at this point.

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Emerging markets bonds are on the verge of breaking support.

Last week, I noted that the iShares Morgan Stanley US Dollar Emerging Market Debt ETF (NYSEARCA:EMB) was still holding up above its moving average support. Well, unless things change for the better this afternoon, EMB will have broken its support. That’s not to say that all is lost – after all, EMB broke support back in August and it managed to rally back to new highs. However, most of the previous times EMB has breached the 14-day moving average, it has meant at least a tough short-term stretch for risk assets was occurring/coming soon.

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High-yield bonds are sending up caution flags as well.

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The SPDR Lehman Brothers High Yield (NYSEARCA:JNK) is shown above and is showing similar signs of deterioration as EMB. This time, however, it is an uptrend line that is being broken instead of a moving average line. Notice also that the RSI for JNK has broken its uptrend line. These developments do not mean new downtrends are the order of the day – just that things have moved from bullish to neutral. We’ll need to see a series of lower highs and lower lows before things turn truly bearish.


The EURUSD is continuing to pull back as expected.

The last couple of weeks have brought nothing but weakness in the euro / US dollar currency cross (EURUSD).  Let’s not go crazy with worry, however, as the rally that preceded this selling was nearly parabolic on the upside – a correction was to be expected.  Even as impressive as the rally was, however, this sell-off could be nearly as vicious on the downside. My call remains for the EURUSD to pull back to 1.23083 (from 1.28 + currently). Such a decline will almost certainly mean more difficulty in equities in the short-term (again, a month end boost notwithstanding).

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The US Dollar Index is rallying as one would expect with the weak EURUSD.

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The US Dollar Index seems to be on a track to retrace most of the July - September decline that occurred. As we’ve come to learn, a higher DXY should mean lower price levels in risk assets and in precious metals. 

The Aussie dollar is not retracing any moves, just fulfilling what appear to be bearish set-ups.

The daily chart of the Aussie dollar / US dollar currency cross (AUDUSD) is shown below.  The AUDUSD appears to be in the early stages of a wave ((iii )) lower with a downside target of 1.00435 (from current levels of around 1.03624).  That’s just the minimum short-term downside target. The bigger picture appears very bearish for the AUDUSD. My question is whether commodities and other risk assets will be displaying similar weakness.  I’m not ready to make such a declaration at this point.

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The chart below shows the Aussie dollar / Japanese yen cross (AUDJPY) on a daily basis going back to mid-2011. This cross also appears to be in a short-term third wave lower with a minimum downside target over 3,200 pips lower than current levels. It could be even worse than that in terms of the AUDJPY. The eventual downside target for the AUDJPY – after this downside, a sideways correction and one more shot to the downside play out – is all the way down at 70.944. That can’t be good for risk assets – especially commodities – can it?

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Overall, the signs are starting to pop up for a correction in risk assets that will finally last more than just a few days. How severe the question will be depends on whether natural market forces will be driving things or whether global central bankers have more tricks up their sleeves.  We’ll see. I, for one, am looking for a minimum of 5% on the downside for the S&P – maybe a bit more for the “beta” indices. The good news is that from there, we should see some more upside – probably heading into the end of the year.
Before I wrap up, here’s a check up on the key European sovereign debt yields:

Much is being made about the happenings in Spain and Greece over the last 48 hours. The fact is, though, that yields on the government debt over there have not really spiked to alarming levels yet.  That’s not to say they won’t – they just haven’t yet.  Stay tuned!

Twitter: @tttechnalytics

No positions in stocks mentioned.

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