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Risk Markets Are Selling Off Currently -- a Needed Correction or Something More Serious?


The currency ETFs are telling a more bearish story than that being told by the individual crosses.

Most of the time, I look directly at the individual currency crosses when analyzing the currency markets. There are a few reasons for that – the No. 1, though, is that I want to see the truest, most "pure" action and then base my decisions off of that. Sometimes, exchange-traded funds can fail to tell the most accurate picture.

That being noted, I want to take a look at the Aussie dollar and Canadian dollar currency ETFs today to see if they're telling the same story as some of their individual crosses (specifically their crosses with the Japanese yen).

Later, I'll examine how the riskier bond sectors are reacting to the correction in equities that we've seen thus far.

The Aussie dollar ETF paints a less bullish picture than the AUDJPY.

  • I highlighted here recently that the Aussie dollar / Japanese yen currency cross (AUDJPY) had closed February out above the 100% Fibonacci price projection line for what would have been an "abc" correction. The bullish action and technical ramifications there were undeniable.
  • However, with currency crosses, one always has to wonder whether the movement in a cross is due to the strength / weakness of country currency A (in this case Australia) or the strength / weakness in country currency B (in this case the yen).
  • The chart above shows the CurrencyShares Aussie Dollar ETF (FXA) on a daily basis going back to mid-2011. Notice that in contrast to the upside breakout that occurred in the AUDJPY last month, the FXA failed to conquer the 100% Fibonacci projection line and has moved lower rapidly off of that resistance level.
  • The game isn't over yet, but the fans may be headed to the exits on this one. The upside in the FXA from October of 2011 to February of 2012 appears to have been merely a corrective move to the upside rather than part of a new bull market.
  • This would mean to me that while the Aussie dollar was in part responsible for the bullish action in AUDJPY, the majority of the reason why it advanced to convincingly was because of the aggressive weakness in the yen (maybe due to a flight from safety and maybe / probably because the Japanese government wanted to weaken the yen to boost their exports).
The Canadian dollar ETF shows the same divergence.

  • The chart above shows the CurrencyShares Canadian Dollar ETF (FXC) on a daily basis. This chart tells the same story as that of the FXA. The weakness of the yen seems to have pushed the Canadian dollar / Japanese yen cross up rather than the Canadian dollar doing most of the heavy lifting there.
So, what does this information tell us about how we need to position ourselves going forward? To me, I would be very cognizant of the potential for a healthy correction in both the AUDJPY and CADJPY at the very least. There may be something more serious brewing on the bearish side, but I'm not ready to make that call yet. A continued flow of evidence coming out of China that things are continuing to really slow down over there would likely be the catalyst of the "more serious" downside situation developing. If China can manage to tap on the brakes rather than slamming on them, then we may just see a correction of the "healthy" variety in the "stuff" currencies.

The yield on the 10-year Treasury Note is correcting after hitting short-term upside target.

  • The yield on the 10-year Treasury Note ($TNX.X) made it all the way up to the higher of the two wave iii targets last week and has begun its wave iv correction / consolidation.
  • The chart above shows the TNX on a daily basis and has Fibonacci price retracement (of wave iii) lines drawn to give us an idea of where yields may bottom out on this move lower.
  • Right now, the potential support levels for the 10-year yield are 2.206%, 2.147%, and 2.087%. That last level is important as it represents the level above which the 10-year broke out last week.
  • We'll likely continue to see some lower yields as long as the correction in risk assets persists. Right now, I'm not of the opinion that the overall risk rally is over yet. So, I would use this pullback in yields (to one of the support levels) as an opportunity to possibly go short of bond prices via the Ultra Short 20+ Year Treasury Bond ETF (TBT). As always, enter wisely and honor thy stops!
The iShares Emerging Markets Bond ETF is going through a much-needed correction.

  • The emerging markets bond sector had been on a nice run along with the rest of the risk asset category. Now, as risk assets are coming back in a bit, so is the iShares Emerging Markets Bond ETF (EMB).
  • The key level to watch is more of a range for EMB (created by the various pivots that can be used to measure out the "abc" Fibonacci price projection lines). The key range to monitor will be the 112.18 to 112.50 level. Any close below the 112.18 level will mean that this is going to be far worse than just a mild correction. Until that level is broken, though, this has to be viewed as a nice opportunity to add exposure to emerging markets debt.
Junk bonds are coming back in as well – and appear to have further to correct.

  • The chart of the iShares High Yield Bond ETF (JNK) is shown above. Just as with the emerging markets bonds and the rest of the risk assets, JNK is correcting here in the short-term.
  • Unlike the EMB, however, JNK appears to have a bit more room to the downside before even the "correction" support level is tested down at $38.88 (just over 2% lower from the 1:15pm EST price on Thursday).
  • As EMB and JNK come in and yields move lower towards their respective targets, a nice "risk on" trade may be setting up once again (long EMB, JNK, and TBT). Remember not to become too attached to that trade or any of those positions, though, as things can and do change rapidly in these markets.
Overall, it looks like risk assets may have some more work to do on the downside in the short-term. However, the correction going on now is likely of the "healthy" variety and should be a welcome opportunity for those who missed much of the run leading up to this correction.
Even if this is something more serious, if you're disciplined enough to have waited for this pullback, the damage should be fairly limited on any stop losses that may be triggered if things get more serious on the downside for risk assets. Good trading!

Twitter: @tttechnalytics

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