Firm euro and yields a toxic mix for EU stocks

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By :  ,  Financial Analyst

The European stock markets spent the first few hours of the open in consolidation mode after a sizeable drop for global markets in the first half of the week. Investors seemed unsure whether to withdraw from the markets or buy the dip, as they have done so consistently in the past. Stock market participants are keeping a close eye on the government bonds, which have sold off in recent days, pushing up yields. The rising yields suggests investors are concerned about the prospects of a rise in global inflation which, if realised, should see the major central banks turn more hawkish and further withdraw the monetary stimulus that have supported both the stock and bond market sup until now. The Fed, which is likely to announce no new changes tonight, has already started to shrink it huge $4.5 trillion balance sheet, while the other major central banks have all dropped their dovish stances. As concerns rise over receding monetary support from central banks, there is a danger that the stock markets could hit the reverse gear.  In the short-term, though, the upcoming company earnings results and the FOMC meeting today are among the event risks which could provide some volatility across the financial markets. But the big elephant in the room is the rising bond yields, which may very well be a negative development for stocks, should they refuse to fall back down.

Euro additional problem for European equities

In Europe, there is an additional problem for stocks: the euro. The single currency has been rising sharply over the past year or so, and is currently just below the $1.25 handle. This is not only bad for European exports, but on a company level it is bad for foreign earnings, too. Hence, the European markets have been far less rosy than their US counterparts. But could they now be on the verge of a correction?

DAX on the brink as it tests key support

Well, the German DAX is just about holding above key support between 13137 and 13172, an area from where it began a rally in mid-January to eventually climb to a new all-time high at 13596/7. That rally took the index above the previous all-time high of 13526, but only for a brief moment. As the index failed to hold its own above the previous high, we had a false break reversal pattern. Now for this reversal to be confirmed, the DAX does need to break below that 13137-13172 support range, which was tested yesterday. In the event this support breaks down then we could see a sizeable correction as the buyers rush for the exits. However, if support continues to hold here, then the buyers would still need to push the index above resistance at 13370 to confirm the resumption of the rally. So, in a nutshell, the DAX is at a very important inflection point and what it does here will be important for the direction of the near-term trend. 

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