U.S. equity indices have continued higher from February 11th lows and it seems all traders are speculating about when (or whether) the next downtrend will occur. Complicating this question is that many typical correlations seem to be breaking down. Take for example both Treasuries and the Japanese Yen. Both usually trade the opposite direction of indices, but lately that isn’t the case, especially in reaction to the March 16th FOMC announcement.
Treasuries and Yen will react to both global risk and U. S. interest rates and it is possible that movements in these instruments is just a reaction to the FOMC projection that rates will only rise an addition 0.50% in 2016 as opposed to 1.00% as previously projected. To tease out whether risk has also been repriced we need to look elsewhere.
Let’s take a look at AUD/JPY which just looks at the relationship of the Australian Dollar to the yen – it will still react to risk, but not so much the U. S. interest rates. From February 11th it also is up and since the FOMC, all it has done is consolidate, perhaps in a triangle. Triangles are usually continuation patterns so unless AUD/JPY falls dramatically, we expect to see it continue higher.
Elliott Wave tells us that triangles are always the next-to-last move in a sequence. So if we do thrust upward from a completed triangle it would warn that a pullback was on deck, but just a pullback before more upside. AUD/JPY seems to be saying risk on.
Another similar message is delivered by high yield corporate credit spreads, the difference in interest rates paid by CCC rates corporate bonds vs. U. S. Treasuries. In riskier environments, greater default risk means corporate’s need to pay more vs. “risk-less” Treasuries. This data can be found from the St. Louis Fed as shown in the chart below taken from their site.
Credit spreads have also come in since February 11th. It’s a little tougher to count waves on a daily close basis; this looks like a five-wave move which suggests that a downtrend in risk has begun. It is possible that the move is late in development, warning that a partial retracement might be due but it doesn’t change the message of risk on.