Signs Point to Short Term Rally in Risk Assets
Looking at the markets in fractals can paint a clearer picture of both the long and short term.
For a good gauge on the prospects for risk assets, we go to the Aussie / Yen cross.
The most telling gauge of risk appetite in the global currency markets is the Australian Dollar / Japanese Yen currency cross (AUDJPY). Sometimes, when equities are zigging, the AUDJPY is zagging – which can be a good warning sign of a change of direction in the equities markets.
The chart below shows the AUDJPY on a monthly basis going back to late 2008. I'm really just trying to get an idea of where the AUDJPY may be headed in the intermediate-term here, so I'm focusing on the right side of the chart.
It looks to me like the AUDJPY may be on the "C" wave of an ABC correction. This is the most optimistic scenario with the highest downside target. In this case, the AUDJPY has a minimum downside target of 74.059 (from today's levels of around / just under 80). As you can see on the chart, this is not a huge move relative to where the cross has traded historically, but five or six thousand pips is pretty big in terms of currency moves (ask any forex trader).
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Is this the time to go short or even remain short with existing positions on the AUDJPY? For that answer, I want to look next at the daily chart of the AUDJPY. This chart basically has the same A and B labels as the monthly chart, but we can see some of the sub-waves of the C wave more clearly.
Right now, it appears to me that the AUDJPY has completed wave iv of C higher and has commenced the final wave "v" of C lower – with a downside target (again assuming that the C of ABC scenario is the reality instead of this wave being a primary thrust lower) of 74.059.
In terms of trade initiation, this chart doesn't give me a great deal of comfort. The upside potential for AUDJPY – even with the ultimate downside target remaining down at 74.059 – is 81.50. That's over two thousand pips and is too much for me to stomach. We have to be able to identify a closer level of resistance than 81.50 for a short-side trade to make more sense right now. For that, let's go to an even shorter time frame / mode – the 60-minute chart…
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The chart below shows the Aussie / Yen cross on a 60-minute basis going back to mid-June. Here, we can see the downside progression that has occurred since last Thursday (6/21). There was a nice first, second and third wave progression from the 21st until yesterday. Then we can see what I believe is an abc correction from yesterday's low to Tuesday mid-afternoon (right now as I type). The limit to this move, assuming this upside is an abc correction, should be approximately 80.194. From there I would anticipate wave ((v)) and (i) to commence – making any entry near that resistance level pretty ideal.
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The question then becomes "Where will the AUDJPY go?" I already noted that the downside target for AUDJPY for wave C of ABC in the first and second chart today was 74.059. That, however, will only be reached after waves (i) through (v) are completed – and we're still only working on wave (i). No, the downside target for wave ((v)) and (i) can be seen in the chart below where we take the magnitude of wave ((i)) and extrapolate that from the peak of wave ((iv)). You can see on the chart that the approximate downside target for this move – assuming our resistance at 80.174 – 80.20 holds up – is 78.945. From a starting point of 80.174 (80.5 as I type), that's a nice short-side trade potential of almost 1,100 pips (which should occur sometime in the next day or so).
Once wave ((v)) and (i) terminates down at around the target level of 78.945, we have to be looking for a wave (ii) counter-trend rally that could conceivably retrace all of wave (i) – so covering short positions down at our target area is a must!
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Overall, the message from the Aussie Yen cross is to look for a bit more downside volatility in risk assets over the next day or so which should be followed by a relief rally of some sort. That is the rally to really sell into as the next move lower will be fairly unpleasant for the risk bulls.
Rates on the 10-year Treasury have remained low as risk assets have been pressured.
There's not been much change in the Treasury picture over the last week, but I like to keep in at the top of people's minds as this market (along with currencies) seems to have been the truth-teller for us rather than equities.
Assuming I'm correct in my call on the AUDJPY above, once we see a short-term bottom there (today or tomorrow), we should see a countertrend rally in risk assets – perhaps lasting several days. If and when that occurs, I would certainly anticipate some higher movement in Treasury yields (lower in prices) as well as some upside in commodities linked to inflation (food, ag-related and crude oil). The upside in crude may be corrective in nature, but the upside in some of the ag-related commodities like soybeans will be a continuation of what we've seen recently. Keep an eye on those food components as they may be telling us something about inflation – more so perhaps than even gold or crude oil. The reason I bring that up here is that inflation rising could be the fuel needed for Treasury rates to rise as the technicals have been suggesting to me since the near-term low of sub-1.5% on the 10-year not too long ago.
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As I mentioned, look for one more shot to the downside for the AUDJPY, the global equity markets and perhaps crude oil in the next day or so, but then we should see a multi-day corrective move to the upside. Play for that move, but don't be afraid to take profits one the recent highs are approached as I do believe that move will only be corrective in nature.
Before I wrap up, here's a check up on the key European sovereign debt yields:
For now, Portugal appears to be "out of the soup." Rates there have fallen through technical support – which means good things for that country in the short-term. Italy, too, is not doing anything alarming in terms of moves in sovereign debt interest rate levels. Spain, however, is the sore spot that continues to throb on occasion. Yields there have backed off of recent highs (from 6/18), but those highs are still fresh. I'd say conditions in and around Spain need to continue to be monitored closely for the time being.
That's it for now -- have a great week!
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