A Relief Rally Is Likely to Follow a Bit More Downside in Risk
The euro and US dollar are nearing technical projection levels respectively while the yield of the 10-Year Treasury Note is telling us something more ominous.
Rates on the 10-year Treasury broke support – back to the drawing board.
"However, I will point out that rates have not yet -- and will not unless they close below 1.564% -- broken technical support. I've been operating under the assumption that Treasury yields will at least head up to 1.809% and possibly even higher." That was an excerpt from my article from last week. Obviously, with rates on the 10-year Treasury trading at 1.525%, a scenario somewhat different from the assumptions under which I was operating is the reality.
I thought that the low that was made on June 1 was a wave (3) bottom. The upside that we saw briefly afterward should have been the beginning of a larger wave (4) counter-trend corrective rally. The likely reality, however, is that the June 1 low was wave (iii) of (3) instead of wave (v) of (3) and that the modest upside correction we saw afterward was wave (iv) of (3). This is the only scenario that makes sense now that yields broke convincingly below 1.564%.
The new downside target for wave (v) and (3) is 1.43% (using the rationale that wave (v) will roughly match wave (i) in magnitude. See the chart below for all of the updated labeling.
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A continued move lower in rates from 1.525% to 1.43% should mean that we see a bit more downside pressure in risk assets in the short-term. What should we expect once the downside target for the yield on the 10-year T-Note is tested? Let's go to a longer-term chart for the answer.
The weekly chart of the 10-year Treasury yield gives us two potential upside targets for yields.
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Assuming I'm correct that we find some footing in rates down at around the 1.43% level for the end of wave (v), v and (3), we all should then be looking for a wave (4) counter-trend rally / correction to follow. As you can see in the chart above, I use Fibonacci price retracement lines (from the peak of wave (2) to the projected bottom of wave (3)) to calculate the likely upside targets for yields. The 23.6% retracement level comes in at 1.976% and the 38.2% retracement level comes in at 2.314%. Both of those targets would represent a significant rally relative to the 1.43% starting point. But when you look where rates were as recently as 2010, it is not that big of a move to contemplate.
Keep in mind that the chart above is a weekly chart. Notice that the move from the wave iv peak (which was right around the higher of our two upside targets) to the projected wave (v), v and (3) low took approximately four months. I would anticipate the move off of the projected wave (3) low taking at least as long as that to run its course.
As you can imagine, a move higher in rates (should it occur as anticipated here) would likely mean a corresponding move higher in risk asset price levels. The strange thing is that as rates are scraping along near their all-time lows, you would think that stock prices would be reflecting the sour outlook by the bond traders with lows / tests of lows of their own. The fact is, though, they are not. Only certain international equity markets are adequately (in my opinion) reflecting the economic realities we're seeing today. What does this mean? Is it that stocks are accurately predicting better times to come? Or are the bond players correct (as usual) and the global economy is still in trouble and stocks need to come back to reality (meaning they need to head lower)?
I'm not sure of the answer, but I tend to side with the bond traders as a rule. Let's see what the currency markets are telling us.
The US Dollar Index is nearing short-term resistance.
So if Treasury yields are falling as a reflection of the "safety trade" being "on," it should follow that the US Dollar Index ($DXY) should be moving higher as part of that same trade. In this case, the DXY is doing as it should.
Using the magnitude of wave i on the chart below, I have projected the upside target for the current wave (presumably wave v and 1) to be 83.72 (a slight increase from the level I gave last week). Does this mesh with the idea that the 10-year Treasury yield is headed to 1.43%? Generally, yes -- but I have a tough time believing the DXY stops at 83.72 given its proximity to current levels while the move to 1.43% for the T-Note is a fairly sizeable relative move.
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So what gives? Will rates really move that low? Or, will the DXY move even higher than 83.72? If I had to bet on only one or the other occurring, I would bet on the DXY moving higher than anticipated. However, it is entirely possible for bond yields to continue lower due to economic concerns here while news out of Europe and globally works to put a lid on the DXY. I would just continue to be monitoring the moving parts individually as well as how they are working off of each other as I formulated my macro outlook. So does the chart of the euro match up with the "limited upside" outlook for the DXY?
Below is a chart of the euro / US dollar (EURUSD) on a daily basis going back to the first quarter of 2012. This is the same chart I highlighted last week, so this should be more of a reminder than anything else. The downside target for the current move lower in the EURUSD remains down at 1.22290. With current prices at 1.23038, that downside target is very, very close to being tested. In fact, I would anticipate that it is tested in the next day or so based on the way it has been trading of late.
Once again, just as with the DXY, the short-term trading target for the EURUSD is far closer than that of the downside target for the 10-year Treasury yield. Just as with the DXY versus T-Note yield fight, I would have to give a higher probability of the euro breaking the downside target. But again, anything is possible – so make sure to watch these things individually and as a group.
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It looks like there's just a bit more downside action in risk assets that needs to play out. Once that pressure abates, however, we should see a corrective rally in risk assets while the safe harbor vehicles such as Treasuries, bunds, the US dollar, and the Japanese yen should start to see some outflows. If you have to choose one chart to assign more importance in the formulation of your opinions, I would probably go with the chart of the 10-year Treasury Note.
Before I wrap up, here's a check up on the key European sovereign debt yields:
What do ya know? We've got a change in the recent pattern over in Europe. Until now, two of the three country's sovereign debt yields I've been following would have a good (or at least OK) week while the third one would have the interrogation lamp shining directly upon it. There seemed to be a constant rotation going with the three countries listed above. However, this week we're seeing a lift in the yields of all three countries' sovereign debt yields. That, along with the still struggling euro, is a bit of an ominous sign.
Hopefully for the bulls, the EURUSD will hold support soon and some of this pressure will abate. If the support on the euro breaks along with a continued escalation of sovereign debt yields from "over there," it may be wise to go to capital preservation mode (if you're not already there).
That's it for now! Have a great week!
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