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Risk Bulls Facing Potentially Ominous Reversals in the US Dollar and Euro

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Targets may have been reached in the DXY and euro.

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Before we get into the charts, I wanted to lay out the schedule of potentially market-moving data points for this week:
  • Monday 8/12: Japanese GDP (already released – came in below expectations; yen off on the news); Japanese Industrial Production (already came in well below expectations; yen off further); Bank of Japan Policy Meeting Minutes (late on Monday)
  • Tuesday 8/13: German CPI; British CPI; Eurozone Industrial Production; German Current Situation / Economic Sentiment; Eurozone Economic Sentiment; US Retail Sales; New Zealand Retail Sales
  • Wednesday 8/14: Aussie Consumer Confidence; German GDP; Eurozone CPI; Eurozone GDP; Bank of England Minutes; British Claimant Count Change; US Producer Price Index; New Zealand PMI; Foreign Investment in Japanese Securities
  • Thursday 8/15: Aussie Inflation Expectations; British Retail Sales; US CPI; US Weekly Jobless Claims; US TIC Flows; US Industrial Production / Capacity Utilization; US Philadelphia Fed Manufacturing Survey
  • Friday 8/16: Eurozone CPI; US Building Permits & Housing Starts; US University of Michigan Consumer Sentiment
Technical focal points coming into this week for currencies and Treasuries.

While the fundamental data flows, here are the pertinent questions for the technical crowd:
  • Will a bullish reversal in the US dollar start / continue?
  • As 10-year Treasury yields pull back off of 2.72% resistance once again, will 2.5% support hold or will we see a test of 2.277%?
  • Will a bearish reversal in the euro to start / continue?
  • Will the bounce / rally in the yen continue or pause? Even a pause would not necessarily take away the likelihood of an eventual rise in the yen up to 1.07.
  • How far will the bounce in the Aussie dollar go? With a short trade that was that overcrowded, there's no telling…
  • Will the British pound continue to work its way up to 1.5783 resistance?
So, now let's take a look at some standout charts.

A combination of technical tells forms a toxic mix for the euro.

Last week, the Commodities Futures Trading Commission (CFTC) released the widely-watched Commitment of Traders report. The report breaks down net long or short positions in all of the traded contracts on the different commodities and futures exchanges. More importantly, it tells us the net positions held by commercial traders, non-commercial traders, and smaller speculators. The key to watch is the commercial traders' net positions.



For the euro futures, the commercial traders' net position has been declining recently as the euro contracts have continued to fly. That's a bearish divergence – in the language of technical analysts. Meanwhile, the price action recently has moved the euro into overbought territory according to the widely-followed Williams %R indicator. The last two times that the COT-Commercials number dipped significantly while the %R indicator was reading overbought, the EUR/USD cross fell from 1.3711 to 1.2744 (2/1 to 4/4) and from 1.3415 to 1.2755 (6/19 to 7/9). So, will last Thursday's peak at 1.3399 lead to a similar sizeable drop? Only time will tell. Interestingly, last week's CFTC COT report also showed a sizeable week / week increase in the net long position in the euro….by speculators.

Technical outlook for EUR/USD.

The EUR/USD topped out Thursday at 1.3399 – just shy of the 1.3414 resistance level that leading technicians have pointed to as critical resistance recently. The candle that the EUR/USD put in on the charts on Friday was not a "key reversal" candle like a bearish engulfing or island reversal, but the EUR/USD cross did close below the mid-point of Thursday's trading range. If we see some follow-through to the downside early this week, technicians may get busy with their calls of a top being made last week.

Also keep in mind that EUR/USD's dreaded "head & shoulders" topping formation is still in play. If that formation plays out all the way to fruition, the EUR/USD will likely slide all the way down to the 1.24 to 1.25 range.

Elliott Wave Theory points to a move down to 92.52 in USD/JPY.

Based on a combination of wave counts, Fibonacci projections, and Fibonacci retracements, Elliott Wave theorists are pointing to the 92.52 level as the downside target for USD/JPY.





EW technicians are saying the USD/JPY cross is in the midst of wave iii of C lower with a downside target at the 100% Fibonacci projection line at 92.52. That level, they say, also corresponds nicely with the 38.2% Fibonacci retracement of the 11/2011 to 5/2013 rally at 92.61. In Elliott Wave Theory, a correction like this "ABC" correction will typically end somewhere in the range of the fourth wave of the previous five wave set. The 92.52 projected target falls within wave 4 of the previous set which occurred from February to March of 2013 and had a range of 90.86 to 94.45.

Even technicians using different disciplines echo bearish USD/JPY call.

Horizontal line support created by multiple price pivots and plenty of trading congestion also comes in a around the 92.50 to 92.70 range. That's more of an echoing of the bearish call above from the EW theorists. Perhaps more interesting is a confirming fundamental / technical call from Citi FX's technical team that notes that the USD/JPY has fallen 82% of the time in August since 1987 through 2011when the Japan-US policy rate differential has been below 2% (which it is now).

Betting sites are showing a sharp increase in the odds of Fed tapering starting in September.

The odds of September being the month the Fed begins to taper now stand at 36%, which is higher than any other month and up from 14% a week ago. This is occurring as the US dollar index was approaching key "correction support" at the 80.51 to 80.66 range. After trading as low as 80.87, however, the DXY has already shown signs of life after the sharp recent decline -- trading up on Friday and, thus far, on Monday.

My downside trading target for DXY was the 80.51 to 80.66 range after 81.13 support was broken last week. Once the anticipated low is established, I believe a sharp move to the upside will occur with an ultimate target of at least 85.00. This type of move will likely correspond with the Fed's tapering program going into full effect.

Summary

So, based on the evidence, I see a tug-of-war going on between yen strength and euro weakness -- both of which are counterintuitive ideas based on recent headlines -- along with strength in the DXY. Typically, yen and dollar strength combined with euro weakness has meant trouble for risk assets -- so be on the lookout for trouble in stocks if these developing trends continue.

Twitter: @seachangereport

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No positions in stocks mentioned.

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