There are lots of questions that need be answered in the markets this week, chief among them being the short-term outlook for equity indices. After the vicious recent falls, shares on Wall Street managed to bounce back sharply in the latter parts of Friday’s session, ensuring a positive close for the major indices in an otherwise bearish week. The positivity has followed through at the start of this week with European indices and US index futures being higher at the time of this writing. So, the key question remains: was that a short squeeze rally on Friday, or the start of a new up move?
Bonds and stocks diverge – for now
A quick look at the bond markets raises a further question: have stocks and bond yields decoupled again? Friday’s reversal and today’s bullish follow-through in the stock markets have not been supported by rising government bond prices. As bonds have continued to sell-off, yields have pushed further higher. The benchmark 10-year Treasury yield has now climbed to above 2.9% for the first time since early 2014. Should yields march further higher – which is quite possible with the upcoming US inflation and retail sales data to look forward to on Wednesday – then there is a possibility the equity markets could be in for another volatile week. Indeed, we think that far too much technical damage has been incurred in the indices for the bulls to make a quick comeback and with all guns blazing. Consequently, we view this as being a “guilty-until-proven-innocent” scenario now. So, Friday’s bounce may well prove to be a mere dead-cat bounce for stocks. But for this to be confirmed, traders require to see further bearish price action now.
Safe haven currencies take their cue from equity markets
Meanwhile as the equity market buyers and sellers battle it out here, FX markets participants should be monitoring price action closely as the outcome could very well impact certain currencies. For example, if the stock market meltdown continues then this should support the perceived safe haven Japanese yen and Swiss franc, among other currencies. However, in the event of a “risk-on” rally then these currencies could be in for a sharp sell-off as traders unwind their “risk-off” trades that they had established last week.
USD/JPY in spotlight
With the stock markets being all over the place at the moment and key US data coming up on Wednesday, the USD/JPY will be in the spotlight for FX traders this week. The unit has been trending lower in recent times, making a series of lower lows and lower highs. Most recently, on Friday, it broke below 108.30-108.45 key support even though the dollar rose against most other currencies. This shows that the yen is indeed a strong currency at the moment. Friday’s breakdown below the 108.30-108.45 support didn’t last long, however, as price ended the day flat. As a result, it formed an indecisive doji candle on the daily chart. Thus going forward, Friday’s high and low will be among the most important short-term levels to watch. A break below the low could see the USD/JPY test liquidity that is resting beneath the 2017 low at 107.33 next. Additional bearish objectives come in at 106.90 and then at 105.50, levels which were formerly resistance. Meanwhile if Friday’s high breaks and price holds above it, then in this case, one will have to consider the bullish argument strongly.