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Bond and Currency Markets Starting to Sound Off Bearishly in Unison -- Finally

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While equity markets have done little more than correct for a few days at a time up to this point, the signs from the currency and fixed income markets are starting to line up in favor of a consolidation / correction for stocks.

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CURRENCIES

The yen's corrective bounce should start soon if it hasn't already begun.

Of all of the currencies, the yen may be the best gauge of what's going on with the risk trade. The Japanese and US markets – along with many of the global equity markets – have been in major rally mode ever since the Japanese yen has been in bear market mode. Well, according to the chart below and the accompanying wave count, the yen may be done going down for now. Based on the wave count, it appears that five waves have either played out or are nearing an end and that a corrective move to the upside is to be expected. I pointed this out last week, but it bears repeating: If the markets rallied as they have with the yen in a bear phase, will they then decline if the yen goes through a healthy upside bounce? By "healthy upside bounce," I mean that I am anticipating a potential move from current levels (around 0.9929) to approximately 1.1041 (the 38.2% retracement of the October 2012 to May 2013 bear move).



The US dollar's outlook is less clear in the short term, but the long term appears to have more upside in store.

The US Dollar Index ($DXY) is shown below on a monthly basis. Notice that even in the more bearish scenario – where the DXY is in a "C" wave of an "ABC" correction to the upside -- there exists nearly 10% of upside potential until the resistance level / ceiling is reached at 91.78. This is not tradable information in and of itself -- we need to see where things are on a daily chart – but it is something worth bearing in mind when formulating your long-term investment thesis.



The daily chart of the DXY is shown below. In this chart, we can see that the greenback is likely in for a little more downside action as wave "iv" plays out. From a current level of about 83.24, I can see the DXY pulling back to either 82.40 or 81.78 without upsetting its overall bullish short and long-term technical pattern. This would likely coincide with bullish action in both the yen and the euro. The yen's chart was featured above. Now let's take a look at the euro's chart.



The euro may be setting up for a bit more of an upside correction in the very short term.

The chart below shows the euro futures contract (@EC) on a daily basis. This price action is playing out pretty much as I have anticipated. I called for a pullback in early May, which was to be followed by a rally up to "right shoulder" resistance level at or near 1.3285. Traders can try to play the remaining upside if they are very, very nimble. However, the next very large move should commence somewhere near resistance and should offer plenty of profit potential for those willing to trade on the short side against the euro. So I'm seeing short-term bullishness for the euro and intermediate-term bearishness to follow.



OTHER NOTES

I must note that both the Aussie dollar and Canadian dollar continue to trade bearishly – although each is reaching oversold levels and could bounce at any point. Those bounces, should they occur, should be used to sell or bet against each of those currencies in my opinion. If I were trading the currency markets directly, I might wait for such bounces to occur in conjunction with the remaining downside in the greenback and then bet with the US dollar and against the risk currencies. If you're not involved directly in the forex markets for whatever reason, you can just use the CurrencyShares ETF offerings (CurrencyShares Canadian Dollar Trust (NYSEARCA:FXC), CurrencyShares Australian Dollar Trust (NYSEARCA:FXA), and CurrencyShares Euro Trust (NYSEARCA:FXE)) as short candidates.

SUMMARY

With only limited downside potential for the US dollar in the near term and the possibility of a pretty substantial corrective bounce in the yen – and the overall bearish charts in the risk currencies and riskier parts of the fixed income arena – I would have to believe that we should see some more short-term difficulty in the equity markets. The caveat, of course, is if the FOMC and its global bretheren continue to keep their collective feet on the gas pedals. If that occurs, much of this well-thought-out analysis is moot. If, on the other hand, they do follow through on "tapering back" on the QE programs, we may finally start to see some more two-directional action. Be ready for some interesting action over the next several months as volume dries up for the summer!

Twitter: @seachangereport

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No positions in stocks mentioned.

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