EMERGING CURRENCIES HAVE BEEN RISING AGAINST THE DOLLAR -- EVEN THE CHINESE YUAN IS CLIMBING -- WHY RISING BOND YIELDS ARE GOOD FOR STOCKS AND BAD FOR TREASURIES -- OTHER BOND CATEGORIES ARE LESS RATE SENSITIVE

EMERGING MARKET CURRENCIES ARE RISING... My Tuesday message repeated the view that the 2010 increase in the U.S. Dollar Index has masked gains in a lot of foreign currencies (mainly because of its heavy weighting in Europe and Japan). I showed February upturns in commodity-based currencies like the Aussie and Canadian Dollars and the Brazilian Real. There are a lot more rising currencies. The black line in Chart 1 shows the Wisdom Tree Emerging Market Currency Fund (CEW) which also bottomed in early February and is challenging its January high. The CEW includes currencies for Mexico, Chile, South Africa, Poland, Israel, Turkey, South Korea, Tawan, India, and China (as well as Brazil). In other words, there are a lot more currencies rising against the dollar than falling. Which suggests to me that the Dollar and Euro are currently out of line with global trends. In other words, the Dollar Index is overvalued at the moment while the Euro is undervalued. I think global traders have figured that out, which explains why stocks and commodities bottomed during February along with most foreign currencies.

Chart 1

EVEN THE YUAN IS CLIMBING... There's been a lot of talk in the financial media about the possibility of the Chinese allowing the yuan to increase in value against the U.S. Dollar (as well as other currencies). Traders are already buying the yuan in anticipation. Chart 2 shows the Wisdom Tree Chinese Yuan Fund (CYB) jumping sharply during April. Although the major trend is still down, it appears to have bottomed. Any appreciation in the yuan is expected to be very gradual. Even so, a rising Chinese currency is potentially negative for the U.S. Dollar. Here's why. Chinese central bankers have to buy dollars to keep the yuan pegged to the U.S. currency. If the yuan is allowed to rise, the Chinese will have to buy fewer dollars. Another market that could be negatively impacted by a rising yuan is U.S. Treasuries. The Chinese have invested a lot of their dollars in Treasury bonds. Fewer dollars means fewer Treasuries to buy. That could result in higher U.S. Treasury yields.

Chart 2

BOND YIELD TESTS 4% ... The 10-Year Treasury Note Yield jumped to the highest level since last June is challenging last summer's high at 4%. I made the comment earlier in the week that rising bond yields were potentially good for stocks (at least for awhile) but bad for bonds. Some readers asked for a deeper explanation. The green line above Chart 4 shows the S&P 500 rising along with bond yields. That's because rising bond yields signal economic strength. Unfortunately, rising bond yields push bond prices lower (bond prices and yields trend in opposite directions). The falling red line below the chart show bond prices falling. In other words, what's good for stocks is usually bad for bonds. [While rising bond yields are better for stocks, higher yields can eventually cause problems for stocks and the economy].

Chart 3

NOT ALL BONDS ARE EQUAL... The part of the fixed income group that gets hit the hardest in a climate of rising rates is Treasury bonds. Other bond classes aren't as sensitive to interest rate direction. High yield corporate bonds are probably the least sensitive. In fact, Chart 4 shows the iBoxx High Yield Bond Fund (HYG) hitting a new recovery high. That's a sign that investors are still assuming risk. Investment-grade corporates are also less sensitive to rising rates, but bear watching. Chart 5 shows the iBoxx Investment Grade Corporate Bond Fund (LQD) falling back to its 50-day average this week and chart support along its January high. So far the support is holding. Any close below the 50-day line, however, would be a sign that higher rates are starting to bite a bit. TIPs may represent one of the best fixed income values at this point. Chart 6 shows TIP iShares (TIP) moving back over its 50-day average after bouncing off its 200-day line.

Chart 4

Chart 5

Chart 6

S&P 500 UPTREND CONTINUES ... The weekly bars in Chart 7 show the S&P 500 drawing closer to potential chart resistance in the 1200-1250 region. The middle of that zone corresponds roughly with a 62% retracement of the 2007-2009 bear market. The weekly RSI line (top of chart) is about to enter overbought territory over 70 (it's currently at 69). In addition, I still believe that the market is in the fifth wave of a five wave advance. Although the market looks stretched at this point, there's no convincing sign of a top. Chart 8 applies Bollinger Bands to a daily SPX chart. Prices have remained above the dotted 20-day average which is the first line of support. If and when that's broken, more substantial support is seen near the January high around 1150. Prices would have to fall below the January high to disrupt the current uptrend.

Chart 7

Chart 8