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Currencies Pointing to a Pause in the Equity Rally, but Nothing Serious


A possible rise in the yen in the short term has the bulls keeping the champagne bottles put away for now.


The dreaded "head and shoulders" topping formation is actually coming to fruition for the euro bears.

A recent break of "neckline" support at around 1.2800 opened up the door for an intermediate-term move to 1.1800 – 1.1900. With the futures contracts on the euro trading at just above 1.2800, a move down to 1.1800 - 1.1900 seems like a long way down. However, such a move (in either direction) is not unprecedented at all. We just saw such a move occur during the first quarter of this year.

Right now, the EC contracts appear to be in wave "3 of III" to the downside. While the wave "III" target is down at the aforementioned target range, wave 3's target is down at the 1.2400 - 1.2500 range – still a nice move lower from current levels. However, the ideal trade would be to wait for more of a bounce (perhaps up to 1.3000 – 1.3100) to initiate or add to short positions (probably via EURUSD or EURJPY if not via the futures contracts).

So if we take the potential for an oversold bounce to occur in the euro and combine that with the potential for the yen to go through a wave "C" upside move in the short-term, we could easily see some corresponding weakness in the US dollar here in the short-term. Let's take a look at the chart of the greenback to see if it echoes this sentiment.

The US dollar is trading right at a crossroads; either the greenback will blow through resistance or it will retest the June lows.

The recent rise in interest rates here in the US has pushed the US dollar futures (@DX) right up to key resistance. Either it will break out above that resistance (likely due to a continued rise in rates – if it occurs), or we will see some major consolidating / backing and filling before the buck makes its breakout move. The chart below shows what the latter scenario may look like.

In this scenario, the DX futures just completed wave "(c) & b" higher and is now commencing wave "c" lower with a trading target at the June lows below 81. Can this scenario really play out? If the euro and the yen are both in short-term bounce mode – absolutely.

So, a weak greenback (risk on), a strong euro (risk on), and a strong yen (risk off)? This scenario could absolutely play out. Add to that the likelihood of some oversold bounces to occur in the Aussie and Canadian dollars and you've got a bullish-leaning currency picture overall – with the caveat that yen strength can possibly override a lot of that. Overall, if things play out as I have laid them out, there are enough cross-currents there to cause just a minor consolidation phase or pullback in equities rather than a major correction. We shall see.

Twitter: @seachangereport

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