Abigail Doolittle's  Instablog

For months I have been writing about complex Head and Shoulders patterns popping up across the various risk-on asset charts including copper, the grains and even the financial sector ETF. 

This week I am writing about the driving complex Head and Shoulders pattern of all of these other patterns and that is the one in the EURUSD as shown below.

This pattern will confirm if the EURUSD passes below its neckline at $1.4046 while its target is $1.3153 and this would make for an 8% decline from current levels.

However, only 50% of these patterns meet the targets set and so there is a strong chance that this one will be stopped by strong support found around $1.35

In fact, such a scenario would be consistent with something I have been calling “EURUSD Pong” or the idea that we will see the EURUSD decline to either $1.39 or $1.35 before moving back up to about $1.50 before then declining to $1.35 or $1.30 or even lower.  The charts of the EURUSD, the dollar index and those of the various risk-on assets strongly support this volatile scheme that I have been writing about recently.

Returning to the complex Head and Shoulders pattern above, it looks set to hit $1.35 or below by late June and right around the time of the June 22 FOMC Statement and the June 30 expiration of QE2 and this could put interesting pressure on Fed Chairman Ben Bernanke to remain dovish to neutral while it may cause ECB President Jean-Claude Trichet to become a bit more hawkish at either of the press conferences following the ECB’s Governing Council Meetings on June 9, but more likely on July 7. 

Irrespective of what sort of policy pong those two might play as has been the case for some time in my view, there is little doubt that any sort of decent fulfillment of that complex Head and Shoulders pattern in the EURUSD will pressure the risk-on trade.  Such pressure may show up as a 5-10% decline in equities and commodities and this will feel severe in the likely and short time frame of the next 3 to 6 weeks.

Such a decline will also serve to confirm the vicious sideways trend in the risk-on assets that’s been present this entire year and for a period of time that is longer than the very vicious sideways trend of this time last year.  In fact, we will soon be looking at an intermediate-term sideways trend rather than a near-term sideways trend and this makes sense considering the tremendous degree of fundamental uncertainty that we’re facing at this time.

Specifically and only to name a few causes of uncertainty: (1) the effect of the end of QE2 on the financial markets and the economy, (2) the sustainability of the fragile economic recovery without government stimulus of various sorts, (3) the still-to-be-seen effect of $100/barrel oil on a fragile economic recovery, (4) a housing market, and the asset class at the eye of the financial crisis, that remains in the gutter, and, (5) the ongoing sovereign debt crisis.

It is this last source of uncertainty that seems likely to flare up over the coming weeks considering the worst-case rumors of Greece leaving the euro, the likely-case rumors of Greece restructuring its debt forcing current bondholders, including many European banks, to record losses of some sort, while it does not help that certain Northern European countries are making Portugal’s bailout a bit more tricky.

All of this comes, of course, in the always present backdrop of contagion fears that can light up instantly with the bond vigilantes pushing yields higher yet and perhaps this is exactly what the complex Head and Shoulders pattern in the EURUSD is telling us is about to happen. 

While I fully expect Treasurys to decline further this year, I think it will come in a volatile and range bound manner and at this moment there are some technical reasons to believe that we may see Treasurys rally in the coming weeks.

First, it appears that potential Triple Top patterns are setting up in the charts of the 7-, 10-, 20- and 30-year Treasury yields with the most defined of these patterns showing up in the 7- and 10-year Treasurys as shown below.

This potential pattern in the 7-year confirms at 2.69% and carries a target of 2.49% while the potential Triple Top in the 10-year confirms at 3.30% and carries a target of 3.07%.

In the case of the 7-year, there’s little support between 2.51% and 2.39% and this may suggest that if the pattern confirms itself, the 7-year Treasury yield may fall to at least 2.39%.  Similarly, it seems that if the 10-year confirms this pattern by sliding below 3.30%, its yield may go to 3.03% or even 2.95% due to a lack of great support around that target of 3.07%.

In turn, such potential moves point to the idea that Treasurys are going to strengthen in price in the near-term since price trades inverse to yield.

Second, the 2- and 5-year Treasury yields appear caught in currently unconfirmed Head and Shoulders patterns that suggest those yields will decline to about 0.45% and 1.70%, respectively.  In truth, the 5-year shown at peaktheories.com passes for a possible Triple Top as well.

Such potential declines in yield also support that Treasurys may rally in the near-term.

Third, the likelihood of Treasurys strengthening in the near-term is supported by a number of ETFs that track Treasurys and all of these ETF charts can be seen at peaktheories.com with the possible patterns marked in.

The chart of IEI or an ETF that tracks 7- to 10-year Treasurys and it appears to be showing a minor and somewhat mangled and unconfirmed Inverse Head and Shoulders that confirms at about $115 and carries a target of $116.50.  The chart of SHY seems to show a better but more minor unconfirmed Inverse Head and Shoulders in SHY or an ETF that tracks 1- to 3-year Treasurys.  It confirms at $84.10 and its target is $84.40.

Both of these potential patterns – as minor as each may be – suggest that we may see Treasurys increase in price in the near-term.

On the reverse side of the ETF spectrum, we have some inverse ETFs that appear caught in Rising Wedge patterns that are attempting to resolve themselves downward.

When these patterns resolve themselves successfully to the downside, it is typically in fast order and this does not seem to be the case here.  This seems to speak to the very reliable Thomas Bulkowski’s observation on these patterns or the fact that “…for downward breakouts, as some of the worst performing chart patterns.”  Perhaps for this reason these potential patterns shown above provide little additional support to the idea that Treasurys may strengthen in the near-term but such patterns certainly seem to be in-line with what we’re seeing with regard to technical patterns in the other charts I’ve shown.

The target for TBT is about $35.00, possibly $34.00 if you’re aggressive with it, while the target on PST is about $39.50.

From a fundamental standpoint, such a rally in Treasurys seems not to match the relative strength of some of the economic data that’s been released as of late, but perhaps there’s a real “surprise” in the pike in this regard.  Or maybe such a move would accompany a strengthening dollar. 

Or perhaps the euro-zone debt crisis is about to flare up again.

The latter would seem to match the swift decline that we’ve seen in the euro against the dollar and, of course, the strength that we’ve seen in the dollar.

Returning to Treasurys though and to the point with which I began: I fully expect the sell-off in Treasurys to resume at some point this year as is also indicated by the charts as is showin in a longer 10-year chart below.

At the end of last year, I wrote about thinking the dollar and Treasurys would be somewhat volatile within particular ranges and this remains true.

Specific to the 10-year, I believe we see the yield move between about 3% and 4% while it seems as though there’s a decent shot it could spend a fair amount of time closer to 4% and this, of course, suggests that a very nice trade both ways is ahead if we do, in fact, see a rally in Treasurys in the near-term. 



In turn, this may say that the bond bust I wrote about a few weeks ago may be muted by a slow unwind rather than a swift and sudden bursting of what is considered to be the great bull market in bonds.