The Dollar May Be Headed Higher Once Again... Trouble for Risk Assets?
With my downside target for the 10-year Treasury note yield hit, a bounce in risk assets is to be expected. Here's what targets to look for in the dollar and HY bonds.
The US Dollar may or may not have hit the support level for this pullback.
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The US Dollar Index looks like it completed a wave iii move higher with its recent peak. The pullback since then seems to be the early stages of a wave iv consolidation / correction phase. Given the fact that the wave (ii) correction was a deep retracement of wave (i), this wave (iv) should be some sort of "flat" correction with a max retracement of wave (iii) of 38.2%. The 23.6% retracement level actually may be the support level for wave (iv) – as it looks like the DXY is trying to post a bullish reversal today.
Keep in mind that the bigger picture for the US dollar is very bullish. The chart below shows a bird's eye view of the DXY. Notice that the current rally in the DXY appears to be part of the larger wave C with an upside target of 89.52 (nearly 10% higher than current levels – which is huge in the currency world).
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The Yield on the 10-Year US Treasury hit the downside target – now what?
For months, I have been calling for a move in the 10-year T-Note yield all the way down to 1.5%.
On Friday, June 1, the TNX actually closed slightly below the 1.5% target as global investors feared for what might happen over the weekend.
On Monday, the June 4, however, a rally in yields began on the back of hopes that a new solution to Europe's ails may be in the offing. That rally lasted until Thursday and the subsequent pullback has only given back some of the gains. Overall, it looks like we're in for some more upside in yields – although it won't be a straight line up.
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The chart shown above gives us some idea as to how high yields can move now that the downside target has been hit. It looks like what we just saw was the completion of wave (3) of 3 and that we are now seeing the early stages of wave (iv). I use Fibonacci lines to give me potential retracements of the previous wave (iii) – which will now act as possible targets for wave (iv). As you can see, the 23.6% retracement line comes in at 1.984% and the 38.2% retracement line comes in at 2.32%.
Either one of those targets would make sense within the rules of Elliott Wave Theory – where the peak of a fourth wave cannot breach the low of the first wave. With yields likely headed higher to either one of those targets, it makes betting bearishly against Treasuries (using ETFs like ProShares UltraShort 20+ Year Treasury (TBT)) an attractive play on any dip in yields.
Junk bonds are rallying a bit, but appear to have much more downside ahead.
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The iShares High Yield Bond ETF (JNK) looks like it is in a wave iv counter-trend rally (similar to what I'm seeing in equities – which I'll cover next).
The max upside for this move in JNK should be limited to the $38.64 level (the bottom of wave i).
As you can see on the chart, the short-term gyrations in JNK are part of a larger C wave lower. The downside target for wave C is $34.57 – more than 10% lower from current levels.
Any close above $38.64 will have me re-thinking things here. However, unless that happens, we must remain sellers of rips in JNK.
Bounces happen – even in bear markets. The bounce in risk assets that occurred over the last week or so may or may not have been "it" in terms of the correction higher. Regardless, even if there's more work to do before this corrective phase is over, the projected upside resistance is close enough to warrant caution in terms of new long positions in risk assets.
Before I wrap up, here's a check up on the key European sovereign debt yields:
Now, it's Italian yields that are on the rise while Spanish and Portuguese yields have come back down. When a solution is offered for one country's problems, the ones not included in the conversation seem to act up. Then, when the talk of help floats over to the country that's acting up, the ones left in the rearview mirror flare up again – and round and round we go.
That's it for now! Have a great week and do what you have to do to preserve capital in this environment!
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