As forecast, EUR/USD is tricky right now

Market Commentary

I was away at the MoneyWeek Conference last week where I gave a talk entitled: “How I make profits in today’s volatile markets’. And just to emphasise the point that today’s markets are indeed extremely volatile, the firs two speakers had diametrically opposed views on the inflation/deflation debate!

I was perhaps one of the first to forecast over a year ago that deflation was about to strike the Western economies. That was at a time when conventional wisdom said that with massive rounds of QE, hyper-inflation would inevitably result. Gold had reached the $1300 area in anticipation of this – and that was a big opportunity to trade against the herd.

And when the herd finally gave up on their belief in hyper-inflation as data came in, gold collapsed to the $1150 area in March. That was one very tasty short trade! Now, it is deflation that has taken over as the theme du jour. And that spells an opportunity to trade against that belief again.

Gold remains on the launchpad under $1200, but as inflationary expectations are being re-kindled, lift-off cannot be far away.

So with the latest CPI data released last week showing a slight uptick in prices, the US Treasury market had anticipated this development by falling out of bed again – and offering another terrific short trade.

My long-time readers will know that the Treasury market is my all-time favourite trading vehicles. But my longer-term forecasts have been guided by the Elliott wave patterns.

Here is a long-range chart of the 10-yr Treasury showing the relentless bull market in prices (bear trend in yields). Many will say that this trend has been promoted by massive amounts of QE by the Fed – and to some extent that is probably quite true. But long-term rates historically are driven by changes in inflation expectations – and these have trended lower and lower since the 1980s. And to the point where, as I said, deflation now is the watchword. That allows for a negative component, of course, and the record-low yields we have seen.

So that initial flurry of deflationary bias accounts for wave 2. But now yields are rising and a break of my green line would send a clear signal that wave 3 up was in force with initial targets in the 5% area.

That makes a short strategy right for the T-Bonds – at least in the medium to long term. But things could be different near term.

To some, that may seem preposterous – with financial repression, how can yields suddenly rocket up from near-zero to these lofty heights, implying a ramp-up in inflation? Economies would be wrecked, some house prices would collapse, unemployment would soar, surely?

And that is precisely the scenario I have been forecasting. However, to get there, we need to see these factors come together to give us another solid monster trade:

Extreme bullish complacency in assets such as stocks, art, real estate. Check.

Extreme bearish sentiment towards long-term rates. Check (see later)

Extreme bearish sentiment towards gold. Check (DSI bulls only around 10%)

Here is a revealing chart of 30-yr yields:

chart courtesy www.elliottwave.com

Last week, bond price bullish sentiment plumbed 8% and into the region of that of six months ago when yields touched 4%. Recall, just over a month ago, bond bulls were 91%!! That is one heck of a switch in sentiment – and confirms the extreme volatility story.

With the first five up and current extreme bullishness, the market is set up to decline near-term to correct that sentiment extreme and my rough forecast is shown by the red lines.

Stocks remain in limbo

The tug-of-war between inflation and deflation has resulted in some pretty wild swings both up and down. I have some excellent wedge breakdowns, but I am fully aware that we could well see one more decent push upwards to finish off the bull.

One aspect of this tug of war is the deflationary implications of a Greece default (which will happen some day) and the inflationary actions of central banks, where money supply in the US and EZ is still climbing.

Here is the FTSE showing this indecision:

Climbing that mountain just above 7,100 took it out of the bulls – market looked very laboured last month, carrying that massive momentum divergence on its back. Now the lower wedge line has been well and truly broken and the decline is in three waves so far.

Market has taken out the first chart support (upper pink bar) and unless it can catch a bid, will be testing the lower pink zone very soon.

DOW

A similar picture here with large wedge having been broken:

Market planted a nice kiss on the lower wedge line and the test of a new bear trend will come if I see a scalded cat bounce.

VIP Club traders remain short from the 18,280 level.

EUR/USD

Market did rally off the 1.09 support area as I forecast, but I was quick to take all profits off the table last week. Why? Simply because, as I mentioned a few weeks ago, the euro is entering a very tricky trading phase and most of the ‘easy’ money has been made.

The market is proving me right as the swings are getting more unpredictable.

Traders should never try to be in the market all the time! I only trade when I have the odds very firmly on my side, and odds are very even at present.