Bonds, Currencies Suggest Risk Assets May Soon Be Making a Short-Term Top
Charts indicate that we are likely to see a 5-10% correction during the summer months once the next bout of selling starts.
Let's jump right into the charts to illustrate more clearly the rationale for my up-then-down call.
The US dollar has been hit hard recently and is due for a bounce.
The US dollar futures (@DX – shown below) have been in the process or correcting lower after a five wave sequence to the upside. So far, the greenback has retraced 61.8% of the December to May up move. The move lower that has made up this retracement (let's call it wave "a") appears to me to have run its course and should now be followed by a wave "b" that will either move up to just below 83 or maybe all the way up to 84.7 (from just under 82 currently). This should either be driven by a little more downside in the Yen (the multi-day breather mentioned above) or renewed weakness in the euro or both. Let's take a look at those charts to see what may be brewing…
The Japanese yen's bounce has put a damper on the carry trade – is there more to come?
The seemingly relentless sell-off in the yen that took place since December looks to me like it was a five-wave sequence that finally ran its course down at 0.9652 (just above my downside projection of 0.9618). The bounce that occurred since the May 22 low appears to have been wave "a" of an "abc" correction. Thursday and Friday's long-tailed candles indicated to me that wave "a" was over and that a few days of downside (wave "b") should take place. The support for this downside action in the Yen should come in at the 38% retracement of the 5/22 – 6/6 up move at 1.0189. If that support holds, then wave "c" should take the Yen up to the 1.1066 level (also the 38.2% retracement of the December to May sell-off). Any break and close below 1.0189, however, will likely lead to a re-test of the recent lows – but I am not calling for that right now. All I am forecasting is for the yen to pull back to around 1.0189 and then resume its correction to the upside. Based on recent relationships, the Yen's projected path should coincide with a bit more upside in stocks and then another downside correction – perhaps taking stocks back down to 1,600 or below on the S&P 500 (INDEXSP:.INX).
The "head & shoulders" top in the euro (mentioned here previously) may be coming to fruition.
In recent weeks' articles here on the Minyanville, I have put forth that the euro futures (@EC) may be forming a "head & shoulders" topping pattern. So far, the series of zigs and zags for which I have called have played out just as I thought they would. Now, EC is trading right at the wave "c" correction resistance level. That level also closely corresponds with the projected "right shoulder" resistance (see the parallel trend lines on the chart). The fact that the Williams %R indicator is reading "overbought" right now is further evidence that the euro's recent upside should fizzle out at or near current levels.
If I am correct and the euro tops out in this "head & shoulders" formation, the next move should push the euro down to at least the 1.2420 level and perhaps down to the 1.2206 level. If either of those two downside targets are approached or hit, it is tough to imagine that other risk assets will be trading bullishly.
The Canadian dollar has also corrected higher in the short-term – more downside to follow?
Another risk currency that has bounced recently after dreadful trading previously is the Canadian dollar (@CD on the futures contract). The CD appears to have just completed an "abc" correction of its own over the last two weeks. If the CD manages to break and close above 0.9812, some more short-term upside potential will open up – but it won't necessarily mean there's no more downside to come. You will also notice that the %R indicator is already approaching overbought levels. This is not normally indicative of much more upside to come on any chart.
So, if I'm making a call on CD here, I would have to go with the idea that the upside correction is over and that another round of downside trading action will take the CD sharply lower. Perhaps there will be a few more sessions of sideways to mildly positive action in the very short-term, but I would be using any such action as an opportunity to sell at more advantageous prices.
The Aussie dollar has remained under pressure despite strength in other risk currencies.
The one "risk currency" that has not participated in the short-term upside action is the Australian dollar (@AD on the futures contract). All we saw from the Aussie was a one-day rally before the sellers came back in and took over. At this point, the Aussie dollar appears to have completed a wave "iii" move to the downside. Both the %R (still close to reading "oversold") and the RSI indicator (higher high despite lower low in the price of the AD) are showing the potential for the AD to at least consolidate higher in the short-term. Perhaps this short-term wave "iv" upside correction / consolidation in the AD will coincide with the little bit of upside in stocks that I have indicated may occur.
Treasury yields should have one more push higher (at least) in the short-term.
The yield on the 10-year Treasury Note still appears to me to have more work to do on the upside before this up move (wave "c & iv" higher) is over. I can see the TNX (INDEXCBOE:TNX) moving up to around 2.283% before the macro downtrend in yields takes back over. Of course, if yields blow through the 2.283% resistance level, all bearish bets on risk will be taken off the table as a matter of discipline. Frankly, however, I believe that rates will top out at 2.283% (or slightly lower) and that rates will then be forced back down by a run to safe harbor as stocks (and other risk assets) sell off over the summer.
So, overall I'm thinking we see the "risk on" trade persist for a bit longer. However, after that we should see a month or two of difficulties for risk assets. Below is a table encapsulating the predicted activity for all of the charts in today's report:
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