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Mixed Messages: The Currency and Bond Markets Are Not in Agreement

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Plus: While stocks have pulled back very mildly, their overall technical position remains solid.

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I always note in my articles that I tend to defer to the messages of the currency and bond markets ahead of the stock market due to the size of those markets and the type of global players in those markets. It is tough for me to remember a time in recent history when there have been so many (matching) cross currents from these very large, very liquid "truth telling" markets.

I will jump into some individual currency trades at the end of the report. However, let us first review the "risk-on / risk-off" evidence being presented to us by the bond and currency markets.

Here is the evidence supporting the (risk) bulls' case:
  • The yield on the 10-Year US Treasury Note (INDEXCBOE:TNX) is still comfortably above support of 1.827% -signaling to the bulls that, despite the recent pullback in rates, things are OK in the Treasury markets.
  • The action in high yield bonds (shown below by the SPDR Barclays High Yield Bond ETF (NYSEARCA:JNK)) is still positive, although JNK will be running right into long-term horizontal line resistance at $41.32 very soon.
  • As pointed out here last week, Japanese yen futures (JYH13 for the March contract) are struggling to hold their monthly support line at 1.144. As I type this, they are trading at 1.1373. A monthly close below the key support is what the risk bulls (and yen bears and Bank of Japan) need and want.
  • Sea Change's proprietary risk tell, the franc / krona "tell," is still sending out bullish messages. The ratio of EURCHF / EURSEK, which shows us the relative strength of the Swiss franc against the Swedish krona, is moving higher – indicating relative strength in the krona versus the franc. When that happens, it is to be considered a positive message for risk bulls (when the franc is dominant, bearish conditions typically exist for risk assets). The chart below illustrates the bullish action in the franc / krona indicator:

Click to enlarge

Here is the evidence supporting the bears' case:
  • While the Aussie dollar is acting well today, the futures on the Aussie (ADH13 for the March contract) remain just below key resistance at 1.0492. Unless and until that level is taken out on a closing basis, I have to consider this a "risk off" message from the Aussie dollar.
  • It's the same story with the Canadian dollar futures (CDH13 for the March contract). The Canadian dollar's key resistance is at 1.0158, however. Both the Canadian dollar and Aussie dollar are important risk gauges due to the influence of commodity prices on their economies. I call these countries "stuff" countries.
  • Meanwhile, the iShares Morgan Stanley US Dollar Emerging Markets Bond Fund (NYSEARCA:EMB) is on the verge of breaking down below a second level of important support today. As the chart below shows, EMB easily closed below its moving average support line yesterday and closed slightly below its "correction support" at 122.20 as well. The break of the "correction support" was only by a penny, so it's still inconclusive. If the breakdown is confirmed, it would clearly be a bearish "tell" for the markets. If EMB can turn it around (it's just above 122.20 as I type), the bulls can move this indicator back over to their side of the ledger.

Click to enlarge
  • Finally, the futures for the 10-Year Treasury Note (TYH13 for the March contract) may have held "correction support" at 131'04.5 on Friday and have bounced since. "Correction support" levels can be a little tricky because they really depend on how you utilize the pivot points in drawing out the "abc" correction. In this case, Treasury bulls / risk bears are seeing a successful test of that support – but the support is created by using very specific points (the series of points that best suits their case). If you use the intraday extremes for those same days instead of closing levels, the support line would come into play at 130'27 and would not work based on wave count rules. So, while acknowledging this potentially bearish signal for risk assets, I would cast a suspicious eye on this – especially given the fact that the yields on the 10-Year Treasury are sending us only bullish messages right now.

Click to enlarge

Summarizing my findings

So, you can see that the bulls have four good points and the bears have four good points (for now). This is why it is very tough to call the winner right now. If I had to, I would give the slight edge to the bulls (given the "reaching" nature for the Treasury futures argument). But, overall, this information is a sign (to me anyway) to refrain from making heavy bets in either direction until we get some more clarity.

For your convenience, here's a table showing all of these cross-currents:


Click to enlarge

TRADE IDEAS

I came across these two trade set-ups in my chart scans over the last few days. The trades haven't run away yet and haven't been stopped out yet, so…

Short the New Zealand dollar / Canadian dollar cross (NZDCAD).


Click to enlarge

The NZDCAD has bounced right up to what may be the "right shoulder" in a potential "head and shoulders" top formation. This set-up could / should be followed by at least a test of the neck line at .81000. More than likely, if it is a "head and shoulders" pattern developing, NZDCAD would trade as low as .78500 - .80000.
  • So, I would be looking to sell NZDCAD at current levels with a stop-loss being triggered on any close above .82967.
  • The downside target will be 0.80000, but we will watch the action carefully at around the .80479 - .81000 range to see if NZDCAD decides it wants to hold support and rally from there instead of fulfilling the "head and shoulders" pattern.
Short the New Zealand dollar / US dollar cross (NZDUSD)


Click to enlarge

Like the previous short play (NZDCAD), the NZDUSD has bounced in what appears to be a short-term "abc" correction higher (making up wave (b) on the chart with resistance at 0.83958). It now looks like we will see wave (c) of the larger (abc) correction with a downside target of 0.80765. So, here is the trade:
  • We'll be selling NZDUSD at current levels with a stop in place on any close above .83970.
  • The downside target will be .80870 (approximately 3,000 pips of profit potential vs. about 150 pips to the stop-loss trigger).
As always, I urge anyone trading in these markets to seek professional guidance. They are very fast and very dangerous if you don't know what you're doing. Always honor stops and size positions appropriately (even if / especially if you're a pro).

That's it for this week's look at the currency and bond markets. If you have questions or wish to discuss / chat about any of this information or the markets in general, feel free to email me at tim@seachangereport.com.

Twitter: @tttechnalytics

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No positions in stocks mentioned.

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