Currency and Bond Markets Have Signals for Both Bulls and Bears
Risk assets finished on a high note last week. However, nothing has changed technically. We've got to look for confirmations from the charts of the euro, the DXY, and the yield of the 10-Year US Treasury Note.
Might the euro / US dollar cross be finished with its upside for now?
Last week, I noted that I thought the US Dollar Index ($DXY) was on the verge of heading back up soon. (See The Dollar May Be Headed Higher Once Again... Trouble for Risk Assets?) So far that has not happened. However, the chart below of the euro / US dollar currency cross (EURUSD) tells me that the euro may be running out of steam very soon (which means the US dollar would then be bottoming out soon).
The EURUSD looks like it is nearing the end of a wave ii correction higher. The max upside for this move should be 1.26672 (from a current level of 1.26445). If I'm correct and this is a wave ii correction, the next move for the EURUSD should be a shot lower down to one of two support levels at 1.23414 and/or 1.22880.
It seems to me that the highest reward / risk entry would be to go short of the EURUSD as close to 1.26672 as possible and to hold on until the downside targets are approached or tested. The good news is that even if a stop out occurs (on a close above 1.26672), the damage won't be too bad.
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The euro / US Dollar is not the only meaningful euro-based currency cross. I've mentioned here before that I have historically used the euro / Japanese yen cross (EURJPY) as a gauge of the global economy and/or the global appetite for risk. With the problems in Europe, I have gone away from using the EURJPY as a pure global economic indicator – although in my opinion it can still tell us about the risk appetite of global investors.
The EURJPY is shown on a daily basis in the chart below. While it is certainly possible that it heads higher, the EURJPY may have already bumped into the wave iv ceiling for now. The Fibonacci price retracement lines are shown on the chart and come in at 100.322, 101.787, and 103.251. While any of those levels would make sense and would fit within the rules of Elliott Wave theory, I would say that either the first or the third levels are the two most realistic possibilities based on the recent trading action. If the first level at 100.322 was "it," then we must expect the EURJPY to travel back down to the 95.58 level (from the current level [as of this report being typed] of 99.479).
Of course, if there is one more shot higher as part of this correction, we would likely see the 61.8% retracement level at 103.251 being tested. The short-term tells for the EURJPY will be 98.091 (a break of which on the downside would mean the bearish scenario is the reality) and 100.899 (a break of which on the upside would mean there is the one last shot higher – likely to 103.251 level).
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The greenback is testing one of the key support levels for this pullback.
As the news flow out of Europe seems to be driving the action in the risk markets recently, we must keep an eye on the US Dollar Index and its reaction to that news. The fact of the matter is that the EURUSD is the main component of the DXY. So, a move lower in the EURUSD as called for above should mean a move higher in the DXY.
The chart below shows the DXY on a daily basis. Notice that the pullback in the DXY has reached the 38.2% Fibonacci retracement level – which in a wave iv "flat" correction should be about as far down as the DXY should go here. Of course, the DXY could move lower to the 50% retracement level at 81.10 without violating the rules of Elliott Wave theory. But again, I was anticipating a "flat" correction rather than a deeper 50% retracement. Friday's close was telling.
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The yield on the 10-Year US Treasury should be working its way higher – which conflicts with the lower euro / higher DXY scenario. Which forces will win out?
The yield on the 10-year Treasury Note is shown on a weekly basis in the chart below. I show this just so we can keep an eye on the bigger picture. As you can see on the chart, there's plenty of room to the upside before even the first Fibonacci retracement line (23.6%) is approached at 1.986%.
Even the modest correction higher in rates called for in this chart kind of flies in the face of the somewhat bearish outlook presented by the charts of the euro and the US dollar above. So, again, it will be interesting to see how things play out over the next couple of sessions. A breakout higher by the euro (and lower for the DXY) would be the scenario that would go along with the projected move higher in rates that I'm calling for in the chart below. On the other hand, if those breakout / breakdown attempts fail, it would be tough to imagine yields ramping higher if the safety trade is "on."
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The chart below shows the 10-Year Treasury Note (^TNX) on a daily basis. We can see that yields moved higher off of the previously identified support area at around 1.5%. After the initial rally (wave "a" or "i"), we saw a correction (likely an abc correction for wave "b" or "ii"). For rates to reach the 1.986% level, the first two moves off of the recent low would have to be "i" and "ii" and not "a" and "b."
Right now, it appears that taking a position on the idea that rates are moving higher (i.e. going long of TBT) in the short term seems like the best reward to risk play.
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Overall, there are some conflicting signals here – bullish signals coming from TNX and the EURUSD (if the upside breakout in the euro occurred) and bearish signals coming from the EURUSD (if the euro instead failed to break out to the upside), the EURJPY, and the US Dollar Index. That is why it was critical to watch the closing levels for EURUSD and DXY.
Before I wrap up, here's a checkup on the key European sovereign debt yields:
As I noted earlier this week, the crisis "over there" seems to be floating around between Italy and Spain. Today, it's the Spanish yields that stand out as most problematic. Their yields have broken through the November high yields and are really signifying continuing problems. Meanwhile yields on Italy's and Portugal's sovereign debt are coming down – not sure if that really signifies anything, but worth noting nonetheless.
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