Bonds Starting to Side With Stocks; Currencies Remain Problematic for Bulls
Treasury yields are on the rise along with junk bond prices, finally offering some confirmation of the rally in stocks. Weak action in the Aussie and Canadian dollars continues to be an issue for bulls, however.
The euro has been in a slump, but it may be poised to turn back up.
In currency land, the euro (@EC for the futures contract) has been slumping recently – but it has had no negative effect on stocks obviously. Now, however, from what I am seeing on the chart below, the euro should be setting up for a multi-week rise as wave "c" of the "abc" upside correction plays out. If this is just a corrective move higher, the rally should top out at around 1.3266. You will also notice the "head" and "shoulder" labels on the chart. If this plays out as it is laid out on the chart, this upside correction will form the "right shoulder" of the larger "head & shoulders" topping formation (a very bearish set-up for those not familiar with the term).
The Aussie dollar should also be nearing a level where a bounce will occur; but it will be short-lived.
One of the worst-performing currencies recently has been the Australian dollar (@AD for the futures contract). The Aussie has broken down badly out of a long-term wedge formation (very bearish) and has broken through both the 138.2% and 161.8% Fibonacci price projections for this move lower (wave "iii"). What the break of the 161.8% projection tells me is that there's a high likelihood that wave "iii" makes it all the way down to the 261.8% projection line at 0.9403 (from 0.9788 currently). That does not mean the Aussie can't bounce for a few days. As a matter of fact, the Aussie is very oversold right now and a bounce should be expected. If a bounce occurs and takes the Aussie back up to the underbelly of the broken uptrend line (new resistance), I would look at that as an opportunity to sell. Overall, the Aussie does not give me any confidence in the "risk on" trade – especially in the commodities part of that trade. The problem with that statement is that the weakness thus far has not translated one bit to the more widely followed equity markets.
The Canadian dollar has much more room to go on the downside.
So, the part one of the "stuff" currency duo – the Aussie dollar – is looking very bearish. How is part two of the duo – the Canadian dollar (@CD on the futures contract) – trading? It is trading very bearishly as well. The Canadian buck appears to me to be in the early stages of wave "iii" to the downside with a downside target of 0.9292 – the 138.2% Fibonacci price projection for this wave. The two indicators that might tell us that the Canadian dollar is oversold are not at this time doing so. The RSI reading is nearing oversold, but is not there yet. Neither is the Williams %R indicator. As with the Aussie dollar, I would be using any strength up to resistance to be selling the Canadian dollar. Also as with the case of the Aussie dollar, the current and forecasted weakness in the Canadian dollar should not, under normal conditions, mean good things for the "risk on" trade. Once again, though, it has not mattered recently.
The US dollar is correcting lower, but should have a bit more upside to follow soon.
Moving on to the safety currencies, the US dollar has seen a nice rally over the last couple of weeks. Had the recent historical relationships held up, that would have meant weakness in risk assets. However, nobody can say the recent action in stocks has been weak. I have to believe, however, that if the greenback continues with this type of strength that it will begin to weigh on the risk trade eventually.
As the labeling on the chart below indicates, the US dollar (@DX for the futures contract) is pulling back in the very short-term. There should be some more downside action in the next few days, but more upside should be soon to follow. Given the breakdown in the historic intermarket relationships recently, I don't know whether the movements in the DX futures will have any effect on stocks. I do, however, think gold and silver may benefit from the DX pulling back for a few days.
The Japanese yen is nearing a key downside projection level; the upside to follow will be corrective in nature.
The Japanese yen (@JY on the futures contract) as we all know has been on a historic slide over the last year (especially since late 2012). My take on where JY is right now, though, is that there may be a little room left to the downside, but that a healthy corrective bounce should begin once my downside target of 0.9618 is tested (JY was at 0.9768 when this report was prepared). The first two potential upside targets for JY on the expected bounce will be 1.0498 and 1.1042 – the 23.6% and 38.2% retracement lines for the 2012 – 2013 JY decline. What will such a rise in the yen do to the global equity rally? Is it acceptable logic to conclude that since stocks have rallied mightily since the October peak in the yen that they may come under selling pressure if the yen bounces as expected? Perhaps, perhaps not – but it something to keep in mind as things develop in the next days and weeks to come.
Overall, I have to admit that Treasury yields and US high-yield debt are finally starting to confirm the rally in stocks. Even emerging market debt is still in a macro bullish position – giving the bulls even more hope. The currency markets are seemingly not being as effective in telling us where stocks may be headed has they historically have been. However, there's still a chance that they are just early instead of wrong or ineffective.
We need to continue to watch the action in the Aussie and Canadian dollars as well as in the more widely followed euro, US dollar and Japanese yen to see if those markets regain / re-establish their predictive power. I will be watching two moves out to see if my call for intermediate-term weakness in the euro, the Aussie and Canadian dollars and strength in the yen and the greenback start to matter to the global equity markets.
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