Financial markets were dominated last week by themes of slowing inflation, a slowing economy and rising expectations for policy easing from both the ECB and the Federal Reserve. This concentration of factors triggered a complete risk-on mode among investors, causing major US stock indexes and Germany’s DAX to soar. At the same time, benchmark government bond yields in both Europe and the United States have fallen significantly. As a result, the euro and dollar were the worst performers of the week, largely underwhelmed by movements in these markets.
Going forward, this risk-on sentiment is expected to continue, and the dollar is likely to remain under pressure overall, except in conjunction with the euro. Various Eurocross technical developments suggest that selling pressure on the euro will continue for some time.
Conversely, the New Zealand dollar stood out as the strongest currency. This is largely due to the RBNZ’s unexpectedly hawkish stance on interest rates. The RBNZ’s new economic forecasts hint at the possibility of further interest rate hikes next year. In addition, Lieutenant Governor Christian Hawkesby highlighted the unintended impact of record net immigration on increasing demand and soaring prices.
Other currencies had mixed performance. The yen was the second-strongest, supported by expectations that the Bank of Japan will lift negative interest rates next year. However, the yen’s rise was mainly against the dollar and euro, and it was unable to break through to last week’s highs against other euros. The Swiss franc ranked third in strength, mainly driven by buying against the euro.
Meanwhile, the pound was relatively weak and the Canadian dollar had mixed performance despite strong employment data. The Australian dollar also lacked a clear sense of direction, with a weaker-than-expected monthly CPI reading reducing the need for further rate hikes by the RBA next year.
Three factors lead investors to embrace strong risk-on sentiment
Strong risk-on sentiment spread among investors in the U.S. market last week, fueling significant gains in major stock indexes and government bonds overall. The DOW soared to a new 2023 high, marking its fifth consecutive week of gains and bringing the total yearly increase to nearly 9.4%. Similarly, the S&P 500 index closed at its highest level since March 2022, further underscoring the bullish trend in the stock market. Although the Nasdaq Composite Index rose, it lagged behind other indexes and remained below its July high. In the bond market, the 10-year U.S. Treasury yield fell sharply, breaking above a key support level of around 4.33% and hitting its lowest level since September.
These positive developments in the market were driven by a combination of factors related to inflation trends, Federal Reserve expectations, and the pace of overall economic cooling.
Inflation trends: Inflation statistics for October showed a slowdown in both the Composite PCE Price Index and the Core PCE Price Index, consistent with investor expectations. This easing of inflationary pressures is a welcome sign for the market, as it confirms that the aggressive price increases experienced over the past year are continuing to ease.
Fed policy shift: Expectations are rising in the market for a change in the Fed’s monetary policy. The federal funds futures market currently indicates a more than 90% chance of a full rate cut in 2024. Expectations for a more dovish stance from the Federal Reserve as it moves from tightening to easing policy are boosting investor sentiment.
Cooling Goldilocks: The gradual cooling of the US economy is recognized as neither too fast nor too slow, and is welcomed by markets. This “Goldilocks” cooling phase is thought to be ideal for easing inflation without causing a significant recession, creating a favorable environment for investment.
Meanwhile, while some market participants interpreted Fed Chairman Jerome Powell’s comments last Friday as leaning toward a dovish stance, Powell was actually quite balanced. He stressed that it is premature to conclude that current monetary policy is “sufficiently restrictive” or to speculate on policy easing. He also said the Fed stands ready to tighten policy further if necessary. But markets appear to be more concerned with Powell’s recognition that the risks of under-tightening and over-tightening are becoming more balanced, and that the Fed intends to proceed with caution. In any case, stock prices managed to widen their rise in response to the Fed and closed at a high.
Technically, the DOW overcame the resistance at 35679.13 and resumed its full rally from last week’s 28660.94. The short-term outlook remains bullish as long as last week’s low of 25280.57 holds. The next target is 36952.65 high.
Broadly speaking, there are still many interpretations of the price movement from 28660.94. Most bullishly, it has already resumed its long-term uptrend. More importantly, the price movement from 34712.28 to 32327.20 is a three-wave consolidation pattern with an upward bias.
In this bullish case, a 100% forecast from 38378.54 to 32327.20 to 28660.94 to 34712.28 is the minimum objective and even a possible breakout of the 40k handle.
The 10-year Treasury yield extended its decline from 4.997 to close at 4.226, breaking the 38.2% retracement from 3.253 to 4.997 at 4.330. The short-term outlook will remain bearish as long as the 55D EMA (currently at 4.498) holds. The next target is the 61.8% retracement at 3.919. With the 55W EMA nearby (currently at 3.942), there could be some notable support between 3.9 and 4.0 psychologically to cap the downside on the first attempt.
One important perspective is that in the W MACD bearish divergence conditions, the 10-year Treasury yield may have completed a shocking 5-wave rise from 0.398 (already the 2020 low). If so, we are now in a moderate correction in this uptrend, and the decline from 4.997 could eventually extend to the 3.253 cluster support (38.2.% from 0.398 to 4.997 at 3.240). Retracement. With this in mind, TNX will break 4% in 2019) the medium-term outlook is nothing fancy.
DAX attracts attention to historic highs as inflation slows and ECB rate cut expected
In the euro zone, investors are reacting positively to a slower-than-expected slowdown in inflation, leading to increased expectations for interest rate cuts by the ECB. Eurozone CPI fell significantly in November, falling from 2.9% to 2.4%, moving closer to the ECB’s symmetrical target of 2%. Core CPI also showed significant progress, dropping from 4.2% to 3.6%. This trend is consistent with broader economic conditions, as the eurozone has experienced a more severe economic slowdown than the United States.
Despite these trends, ECB President Christine Lagarde has warned against premature celebrations in the fight against inflation. He remained cautious, stressing that “this is not the time to start declaring victory.” He echoes his views, and some ECB officials have also indicated that discussions about rate cuts are premature. Nevertheless, market sentiment is increasingly leaning towards the possibility of an ECB rate cut, with some economists advancing expectations that the first rate cut will occur in the third or second quarter of next year.
German investors welcomed the development, despite the laggards in French stocks. The DAX accelerated its rise last week to close at 16,397.52, just shy of its historic high of 16,528.97. For now, the near-term outlook remains bullish as long as the support at 15915.40 holds. A decisive break at 16528.97 would pave the way for a 61.8% forecast from 14630.21 to 17513.87 to 11862.84 to 16528.97.
At the same time, the 10-year German Bundestag yield continued its downward trend, closing at 2.360, its lowest level since June.
The dollar index rebounded on the euro’s weakness, but fell below near-term resistance and reached its upper limit.
The net result of the above developments is that the euro and dollar ended the week as the worst and second worst performers, respectively. Therefore, the rebound seen in the dollar index was largely due to the euro’s depreciation, rather than the dollar’s inherent strength.
From a technical analysis perspective, the 61.8% retracement from 99.57 to 107.34 at 102.53 is an ideal level to provide support for DXY to form a short-term bottom. However, the key condition to confirm this bottoming pattern is a break above the resistance at 104.21. In this case, a move back above the 55 D EMA (currently 104.69) would see a stronger rebound.
For such a rebound to materialize, two major market movements are needed. That would be a significant drop in EUR/USD and ideally a sustained rebound in USD/JPY. Collectively, these movements would support a bullish scenario for the dollar index.
Conversely, if the price remains firmly below last week’s low of 102.46 and continues to trade below 102.53, it would indicate a continued decline from the high of 107.34. In this bearish scenario, DXY could extend the decline and retest the low of 99.57.
EUR/CHF, EUR/GBP, EUR/AUD are bearish
Several important technological developments in the euro are noteworthy. The sharp decline in EUR/CHF should confirm the rejection by the 0.9691 cluster resistance (38.2% retracement from 1.0095 to 0.9416 at 0.9675). The decline from 1.0095 (2023 high) is still underway. Based on the current strong momentum, EUR/CHF could also resume its long-term downtrend.
We should see a retest of 0.9407 (2022 low) soon. A decisive break here would confirm the bearish case and pave the way for a 61.8% forecast from 1.0095 at 0.9018 to 1.1149 to 0.9407, which is close to the psychological level of 0.9.
The sharp decline in EUR/GBP also suggests that the rebound from 0.8491 has been completed as a corrective move towards 0.8764. The downtrend from 0.9267 is likely still underway. Next we should see a retest of the 0.8491 support. A decisive break here would confirm this bearish case and target medium-term channel support around 0.8413.
EUR/AUD’s strong break from medium-term trendline support asserts that the decline from 1.7062 has already corrected the entire uptrend from 1.4281 (2022 low). In the short term, we will see a deeper decline at 1.6000 to the 38.2% retracement from 1.4281 to 1.7062. There is strong support for a backlash. However, a solid break through this Fibonacci level will open the way to the 61.8% retracement at 1.5343.
EUR/USD weekly outlook
EUR/USD rose to 1.1016 before reversing. A breakout of the 1.0851 support should place a short-term top in 4-hour MACD bearish divergence conditions. The initial bias for this week is slightly to the downside at the 55 D EMA (currently 1.0766). However, on the upside, a break through 1.1016 would restart the rally from 1.0447 and retest the 1.1274 high instead.
In perspective, the price movement from 1.1274 is seen as a corrective pattern up from 0.9534 (2022 low). The rise from 1.0447 is provisionally considered the second leg. Therefore, while we see further upside, the upside should be limited to 1.1274 to bring about the third leg of the pattern. On the other hand, a sustained break of the EMA 55 D would argue that below 1.0447 the third leg has already begun.
In the long-term situation, the long-term bottom is at the bullish convergence condition of M MACD at 0.9534. It is still too early to call for a reversal of the bullish trend as it remains within the descending channel. Nevertheless, it will continue to trade above the 55 million EMA (currently 1.1081) and a break above the 1.1274 resistance will increase the likelihood of a reversal, targeting the 1.2348 resistance for confirmation.
