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Risk Markets Should Be Set to Bounce - Even if It's of the 'Dead Cat' Variety


The key currency risk gauges have met their downside targets in the short-term and should be set to rally. Will it be a corrective rally or another primary move higher?

MINYANVILLE ORIGINAL Unfortunately for the bulls out there, I'm seeing some potentially bearish developments in the key currency gauge of risk, the Australian dollar / Japanese yen cross (AUDJPY). Fortunately for the bulls, however, I am not seeing any clear confirmation (yet) from euro / Japanese yen cross (EURJPY). So, while a yellow caution flag has gone up, no red flags are being waved just yet.

Let's take a look at how things are looking right now:

The Aussie / yen cross has a bearish scenario that we need to consider.

Click to enlarge

The Aussie dollar / Japanese yen currency cross closed above the 100% Fibonacci price projection line ("correction resistance," which is shown using the dark red lines on the chart) on a daily and monthly basis in February of this year. That breakout had me believing that risk assets were in a new bull market phase and that every dip was to be treated as buyable. In the case, the peak in March would have been a wave 3 peak. The problem comes in the fact that the decline since the March peak has taken the AUDJPY below the late October / early November closing peak (which should have been wave 1). In Elliott Wave Theory, wave 4 (which would have been this recent decline) should never close below the wave 1 peak. Well, in this case, the April close already violated that rule and the action early in May has shown no signs of the AUDJPY changing course.

Could the breakout above the 100% Fibonacci lines in February and early March have been something other than a third wave? If so, what is the correct wave count? Notice first that the AUDJPY did not close the quarter out above the 100% Fibonacci resistance line (see the yellow box). That fact in combination with the fact that the AUDJPY is easily breaking and closing below the October / November peak has me thinking that the March peak was the C wave of an ABC correction and that this most recent downside is the first wave of a new primary wave set lower. That could spell trouble for the risk bulls out there in the intermediate-term (this is the aforementioned yellow caution flag).

However, that bearish scenario being noted, I do think that we're at or near the end of the corrected wave v & 1 (as wave v has already met the downside target where wave v would match wave i in magnitude). The next move in the AUDJPY – even under the more bearish scenario I just outlined – should be a wave 2 higher. Second waves typically are fairly deep retracements of their predecessors, and I have laid out the possible upside targets for wave 2 on the chart (see the bright red Fibonacci retracement lines). Even if AUDJPY only retraces 38.2% of the March to May decline, it would give traders an opportunity to catch a 1200 - 1300 pip move in the currency (which in most forex pros' books is "tradable"). The 50% and/or 61.8% retracement levels are probably even more likely targets, again because of the fact that this is likely a second wave correction. Therefore, I for one will be looking to play the AUDJPY from the long side in the short-term with an eye on the more bearish trade to come later this year.

The euro / Japanese yen currency cross is also set to bounce – and it is not showing the same bearish pattern as the AUDJPY.

Click to enlarge

As mentioned above, under the more bullish scenario, the euro / yen cross is not displaying the same bearish breakdowns / failures to hold as the AUDJPY. The bullish scenario for the EURJPY is that the March peak was a wave 1 peak and the current weakness is the "a" wave of an "abc" correction. In that case, there are four possible resistance levels for the euro / yen cross, which are arrived at by projecting where the "c" wave of the "abc" correction may finish. Once we identify those possibilities, we can then work backwards and figure out where the "b" wave of the "abc" must terminate in each of the three "c" scenarios.
  • So, in the case where the "abc" correction is a 100% retracement of wave 1, the "b" wave of the "abc" would have an upside target of approximately 105.24.
  • In the case of a 76.4% retracement of wave 1, the wave "b" peak would come in at approximately 108.6.
  • In the case of a 61.8% retracement – which I view as having the highest probability of occurring – the wave "b" peak would be 110.7.
  • Finally, I have to note that the 50% retracement level (of wave 1) has already been tested with the "a" wave. Therefore, if that level were to be the end point for wave "c" of the "abc" correction, wave "b" would have to be a re-test of the recent highs at 111.428.

Click to enlarge

In the more bearish scenario for the EURJPY (shown above), the March peak was not a wave 1 peak, but rather the end of the "C" wave of an expanding flat correction (wave "A" would have been the October / November peak and wave "B" would have been the January lows). If this scenario is the reality, it would fit right in with the bearish AUDJPY set-up. Unfortunately, there's no way of knowing for sure if the bearish case is the reality unless and until the EURJPY were to break and close below the January lows (that's a long way from current levels, though, so it's not much help right now).

Regardless of which intermediate to long-term scenario is the reality for EURJPY, the short-term should bring about a bounce of at least 900 - 1000 pips up to the 105.159 level (which I would consider "tradable" just as with the AUDJPY short-term set-up).

So, in terms of currencies, we must be cognizant of the bearish possibilities while hoping (for everyone's sake) that things will improve and/or continue to improve around the world. When the messages are not as clear as we'd like them to be from one chart or one asset class, we must do the work on the other asset classes to look for confirmations or divergences that will help point us in the right direction.

Due to the length of the material on currencies today, I won't go into a full analysis on the messages being sent from the bond markets. Suffice it to note, however, that government bond yields here in the US are on the decline (as I've been expecting) and appear set to continue down to my 1.5% target on the 10-year Treasury note. This is clearly reflective of the downward turn in the economic conditions and numbers here in the US recently.

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

A decrease in yields – albeit a very slight decrease – for Italy and Spain is good news. On the other hand, it isn't good to see yields on Portuguese sovereign debt back on the rise. This is definitely worth monitoring.

That's it for now! Have a great week!

Twitter: @tttechnalytics

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