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Expect a Short-Term Correction in Risk Assets


Forex and treasury markets are hinting at a pullback, but any drop will be followed by a return to the current dominant trends.

While many of us with a voice have expressed our concerns about how all of this (the never-ending stimulus for the markets on the part of the FOMC and other central bankers) ends, the day of reckoning for global risk assets does not yet appear to be at hand.  Instead, the global markets are telling this analyst that a modest pullback in risk prices may be in order -- only to be followed by a continuation of the dominant trends (higher for stocks being the primary one). 

What are the bond markets telling us?

The yield on the 10-Year US Treasury Note (INDEXCBOE:TNX) is shown below on a weekly chart going back to 2011.  It appears to me that yields completed an "abc" correction to the downside for wave "4" about a month ago, and have since commenced with wave "5" higher, which should eventually take yields up to near the January peak at around 3%. 

As this is a weekly chart, I must note that a re-test of the recent low near 2.45% is certainly possible -- and seems more possible after the FOMC commentary yesterday.  A pullback in yields would make sense given the overbought condition in stocks currently and the possibility (if not likelihood) of a pullback in prices there.  

My thought is that such a pullback in yields and stock prices would just be setting up for a more substantial move up in both, though.  It is very likely that the eventual move up in yields towards 3% would coincide with S&P (INDEXSP:.INX) futures moving to points north of 2000 and maybe even north of 2100. 

I must note that any close below 2.452% on a weekly basis will negate this playbook altogether and would likely mean more of a downside correction in stocks is occurring alongside the (surprising) continuation of the downward move in rates.

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Are stocks marching in formation as they should be?

I put forth recently that 1935 should have been the wave ((iii))) target on the upside for the S&P e-Mini Futures (ESU14 for the September contracts).  That level was eclipsed on a daily and even a weekly basis, but it has not yet closed above that level on a monthly basis.  Given how overbought the large cap portion of the US equity markets are, I would not be surprised to see a dip back below 1935 prior to month's end.  Let's put it this way: Given how far skewed things are in terms of bullish sentiment nowadays, the path of greatest pain for the masses would seem to be for a correction lower to occur in the short term. 

Click to enlarge

Can the currency markets tell us anything new?

Today, instead of focusing on the US dollar, I wanted to take a look at the Japanese yen as our "tell" for where safety assets are flowing (or from where they are fleeing).  The weekly chart of the yen below goes back to 2011.  Right now, it appears that the yen futures (@JY) may be in the midst of wave "(iv)" higher of wave "iii" lower.  The wave "(iv)" ceiling should be no higher than 1.0077 to 1.0092, which is a nice little upside trade from current levels.  Upside like that should, in theory, coincide with a short-term move out of risk and into safety on the part of global funds. 

Once the wave "(iv)" move higher terminates, however, there will almost certainly be more of a move lower by the yen, which would, in turn, coincide with a move higher in risk assets. The move lower in the yen futures should take prices down to the January lows at near 0.9496.   

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Wrapping it all up...

Based on what I'm seeing across the asset classes, we may see a very modest short-term decrease in the prices of risk assets -- perhaps just to let some of the built-up pressure out of the balloon.  I can see the S&P e-Mini futures drift down to around the 1850 level without any real technical damage being done. That drop in stocks should coincide with a continued drift lower in interest rates (to test the January lows) and a rise in the Japanese yen (and maybe other safety currencies like the Swiss franc).  Once these corrections in risk assets (and rallies in safety assets) run their course, however, expect things to revert back to the dominant trends (bull market in risk and bear market in safety).  There may be a day of comeuppance eventually for the risk markets -- one in which a massive bubble in safety assets is burst and systemic concerns once again dominate the global conversation --  but this anticipated short-term correction does not appear to be where that comeuppance will commence.

Twitter: @seachangereport

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