Stock market direction dominated by EUR/USD

A clear pattern has emerged in the financial markets concerning stock indices and the EUR/USD currency pair. As can been seen from the comparison chart in figure 1, below, the major euro-based stock indices, such as Germany’s DAX, have rallied in the single currency’s slipstream. This makes sense as a weaker euro means more profits for German exporters. Although shares on Wall Street have managed to hold their own pretty well so far, the stronger dollar is finally weighing on US exporters. The chart in figure 2 shows how the S&P 500 has moved inversely to the dollar’s rally. The dollar’s strength has also weighed on the commodity-heavy FTSE, vis-à-vis the buck-denominated gold and oil prices.

But now that the dollar index has reached the psychologically-important 100 level, will the US and UK stocks begin to outperform their European peers? As much as I am tempted to say yes, there is no reason for the dollar rally or the euro slump not to continue, for after all today’s bounce back in the EUR/USD and other major FX pairs looks to be technically driven. For example, the EUR/USD has bounced off a psychologically-important level of 1.0500; the GBP/USD has found some support at its 61.8% Fibonacci retracement level (1.4910) of the upswing from the 2009 low, and as mentioned the dollar index itself has hit the 100 hurdle. Thus, once this profit-taking phase in the FX markets ends, the flow of funds from US stocks to European markets may resume. But even without the weaker euro, most of the European stock markets may still have a lot of catching up to do with their US peers as economic activity picks up momentum in the euro area and as the ECB’s bond purchases program continues to push yields further lower, driving investors into European equities. So, regardless of the impact of the FX rates, we remain fundamentally bullish on European stocks.

Indeed, the Euro Stoxx 50 index (see figure 3) looks to be on the verge of another bullish breakout after forming a Marubozu-like candle on its daily chart on Wednesday. At the time of this writing, the index was testing support at 3630/45. The lower end of this range was the recent high that was taken out following yesterday’s rally, while the upper end is the 200% extension of the last notable downswing that took place in December (from point C to D on the chart). Should support hold here then a move towards the next set of Fibonacci levels may begin. These are:

• 3835: 200% extension of AB swing

• 3870: 261.8% Fibonacci extension of CD swing

• 3970: 78.6% Fibonacci retracement level of the upswing from

Our short-term view on the Euro Stoxx 50 remains bullish for as long as it can hold above the bullish trend line. If however it breaks through it and also take out support at 3550, then a pullback towards the 50-day moving average, currently at 3376, or horizontal support at 3305/10 may get underway.