The SPX is waiting for a signal from its correlated markets

As the equity markets continue to extend their gains into the fall season, we continue to look at what the implications will be on currencies, and what potential outcomes we may have in the current environment. 

We now have a new blog post on US Equities here

As I referenced on Twitter Friday (@pipczar if you don’t already follow me there), I alluded to the SPX being at the ascending wedge support, which had to be defended by the bulls. As expected, the bulls came through and kept the market supported, despite some of the longer term technical indicators deteriorating. First and foremost, the development we have (below) is an ascending wedge, and by default it is more than likely an eventual reversal pattern. But keep in mind it is not a reversal pattern until it is, and what I mean is that the market is bullish until the lower trend line of the wedge is broken on a sustained basis. The daily RSI (Relative Strength Index) continues to diverge, signalling that a potential top is in the making. One thing to note is that the 200dma has had a steady rise and any setback in the market will probably be very well supported, even if we see a near-term drop-in price due to a reversal. But a potential reversal/pullback may be only short lived.

Ascending Wedge

One of the major reasons I think that a potential reversal is brewing is that we are seeing bonds trying to form some sort of low near term. A lot of traders think that a continued rise in yields (fall in bonds) may be the straw the breaks the back of the equity markets. However, the low in bonds near term could suggest a possible shift into safe assets like US treasuries. If you look at the 10yr bond market, you will notice major support developing (near the 50% retracement of the long term 2007 lows to 2012 highs) and as long as this low holds, we could see a shift of funds moving out of equities into “safe haven” type of vehicles like bonds. I am watching for the previous support at 119’02’ and if this level is broken, a longer term double bottom could be forming in the 10yr.

So, what does this mean for the FX market? One of the best correlations in the market is the inverse relationship of bonds and the USDJPY. If you overlay the two, you can see the inverse relationship is quite clear.

JPY - Treasuries Correlation

Taking this into account, the USDJPY has broken higher above the 113.20 level squeezing JPY longs (USDJPY shorts) out of their positions. It’s been a great run as of late, but if you look a little longer term, the 114.00/40 level should offer some stiff resistance as this is a lot of horizontal resistance spawning back to the spike highs through the summer of 2017. The DSI (Daily Sentiment Index) reading is also at a staggering 10 showing extreme bearish sentiment of the JPY which can be looked as a possible contrarian indicator in the coming sessions.

In addition, the COT (commitment of Traders) report from Friday is showing speculators fairly short the JPY as well which is also a potential contrarian indicator headed into next week.

What I will be watching is equities and bonds. If bonds continue to rise and equities break lower through the ascending wedge support I may start hunting JPY longs (XXXJPY shorts) as I think some of the weak hands were squeezed through the move through 113.20 and could show a reversal next week at some point.

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Blake Morrow

Forex Analytix