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The Tea Leaves From the Currency and Bond Markets Are Still Bitter for the Bulls

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Despite a one-day rally in risk assets, the bears remain firmly in control of the situation for now.

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MINYANVILLE ORIGINAL When we get a rally in stocks like we did yesterday, it is tempting for those who have been properly defensively positioned to second-guess themselves a bit. But, if you're able to keep you eyes on the less easily manipulated fixed income and currency markets, the tendency to be drawn in by the siren's song may be less of a problem.

For weeks and even months now, the tone of my weekly pieces on the currency and fixed income markets here on Minyanville has been quite bearish. Unfortunately for the risk bulls out there, the message this week remains the same – BE CAREFUL!

Now to the charts:

BONDS

The Yield on the 10-Year Treasury inching towards my downside target.

First we go to the weekly check-in on the 10-year Treasury Note yield ($TNX.X or TNX for short).


Click to enlarge

Nothing has changed from a technical perspective here – yields are headed lower. My projection of a 1.5% yield TNX remains intact. Some out there are actually calling for much lower yields – Gary Kaminsky on CNBC is calling for 1% yields for TNX. I'm not saying he is / they are wrong by any means – it's just that the measuring technique I am employing here (where wave 5 would roughly equal wave 1) tells me that 1.5% is the downside target for now. As has been the take away with the action in Treasuries recently for some time now – there are more rough times ahead for the bulls.

High yield bonds in trouble here – even in the most bullish scenario.


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High yield bonds, shown above using the SPDR Lehman High Yield Bond Fund (JNK), may have just completed an "abc" correction higher in the very short-term. The downside pressure in risk assets this morning certainly doesn't do anything to contradict that idea. I should note that JNK could rally a bit higher to $38.96 without negating this bearish setup. However, If the upside correction is over, then we have to try to establish where JNK may be headed next.


Click to enlarge

As the chart above shows, the bigger picture on the JNK confirms the bearish setup that we see in the shorter-term chart. I am using the most bullish possible wave count on the chart – where the JNK is in the C wave of an ABC correction lower with a downside target of $35.39. Hopefully for the bulls, this is the reality. Even if it is, though, a drop from current levels (around $38.70) to the downside target would be painful enough for some of you to consider a proactive exit right now. If this "bullish" scenario is not the reality, the other more bearish scenario would likely unfold. That would be where this current down leg is a third wave lower instead of the C wave lower. That would mean much lower targets and much more misery for the risk bulls out there. Either way, JNK has enough downside potential to merit taking a pass on any long exposure here for the time being.

So, in bond land the message remains consistent – sell rallies in risk!

CURRENCIES

The move lower in the euro is far from being over – even if looking through the rosiest glasses.

The euro seemingly has been going lower on a daily basis recently. Just when we think the decline has reached a peak in intensity or that the US Dollar Index has reached a point where a pause or consolidation is in order, the some new concerns about something else "over there" pop up. Last week, it was Portugal that had global markets concerned. This week, it's Spain that appears to be in the spotlight.


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When the selling in any security or contract gets this intense, the cries of "how low can this go?" inevitably are heard. The chart above shows the euro / US Dollar currency cross (EURUSD) on a monthly basis going back to 2002. What this chart tells me is that the EURUSD has, for the most part, been in a large trading range (with a modest lower trend) since early 2008. The seeming lack of trend has been enough to drive many Forex traders away from this cross. However, in looking at this chart in a certain light, one could paint quite the bearish picture for the euro – one that actually makes sense of the gyrations over the last four years.

Take a look at the way the EURUSD's waves are labeled on the chart. To me, it looks like the EURUSD may be in wave iii of 3 lower with downside targets of 1.1141 and / or 1.04609 (based on Fibonacci price projection lines). Those who follow Elliott Wave Theory know that the "third of a third" wave in a sequence is typically the most powerful wave there is in EWT. So, to me that means that the higher likelihood target would be the 1.04609 level on the EURUSD. Consider the type of headlines and misery in risk assets that would accompany such a move – no matter how optimistic you may be, it's a very scary thought. Even if my wave count is off and this is a corrective wave lower instead of a primary move lower, the EURUSD would have a minimum downside target of 1.21716. As with the situation with JNK, the downside to even the more bullish targets seems to be too enough to warrant taking capital preservation measures at this point.

So, what to do?

Based on what the fixed income and currency markets are telling us, it is still time to play defense. Going forward, I will continue to keep my eyes on the key gauges of risk I've been sharing with you all recently – the yield on the 10-year Treasury; the action in JNK and iShares JPMorgan USD Emerging Markets Bond (EMB); and, the action in the AUDJPY, the CADJPY, the EURJPY, and the EURUSD. Stocks seemingly can be manipulated (too easily for my taste) by the powers that be. However, the much larger, more liquid fixed income and currency markets appear to have been a more reliable "tell" for market observers. Stay with them as long as they continue to remain this accurate.

For now, tread lightly in risk assets and focus any efforts in that arena on areas that have little credit risk and limited exposure to the happenings in Europe.

Before I wrap up, here's a check up on the key European sovereign debt yields:



It appears that global markets have been attempting to game which of the three potential problem countries – Italy, Spain and Portugal – will be the next victim (some would use the word cause instead of victim) of the sovereign debt crisis in Europe. Last week, it was Italy and Spain that improved their situations while Portugal looked like trouble. This week, Portugal's yields have come back in while Italy and especially Spain look like things are heating up (in a bad way). Spanish yields broke through some resistance over the last week and now only have the 2011 peak at 6.729% as resistance. Italy's yields are on the rise, but no technical levels have been taken out just yet. Right now, the focus is on Spain and the potential ramifications of intensifying problems there.

That's it for now! Have a great week and do what you have to do to preserve capital in this environment!

Twitter: @tttechnalytics

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No positions in stocks mentioned.

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