DAX outlook remains positive amid ECB rate cut expectations

• DAX outlook: Dovish ECB could support European stocks
• Promising signs for indices after slow start for risk assets in 2024
• DAX technical outlook: key levels to watch

The markets have been largely in wait-and-see mode ahead of the release of US inflation data, with traders sitting on their hands amid a lack of any major news or central bank announcements. Sentiment in global markets outside of China and Hong Kong has remained largely bullish, although we have seen fading momentum in some markets while others like the Japanese markets have found fresh impetus, causing the Nikkei index to break to a new multi-decade high overnight. In Europe, the major indices were a touch weaker at the time of writing, with US futures also little-changed. We maintain a modest bullish view on global indices given the increased likelihood that the major central banks will be easing their monetary policies this year. The German DAX could be gearing up for a potential breakout to a new all-time high.

DAX outlook: Dovish ECB could support European stocks

We have heard from several European Central Bank doves this week, all providing hints that the central bank could start cutting rates in the coming meetings, possibly as early as in the first half of 2024. This is something that Governing Council members of the ECB Francois Villeroy and Mario Centeno have indicated. Today, we will hear from Luis de Guindos and Pablo Hernandez de Cos, both also appear to be in the dovish camp. Isabel Schnabel, who is more of a hawk, will be speaking at 1400 GMT. Given that there remains evidence of sticky inflation, Schnabel may again push back against rate cut bets.

German data point to recession

One reason why the ECB may turn dovish quicker is because of the economic performance of Germany. The economic powerhouse is running out of fuel amid high inflation and interest rates. Yesterday we saw that industrial production unexpectedly fell 0.7% month-over-month, adding to the 0.4% decline recorded in the month prior. The data points to the Eurozone’s largest economy heading towards a technical recession, but it also helps increase the likelihood of a sooner-than-expected rate cut by the ECB.  

On a more positive note, Italian retail sales (+0.4%) and French industrial production (+0.5%) both came in higher than expected this morning.

Promising signs after slow start for risk assets in 2024

The first week of 2024 saw risk assets pullback. This week, we have seen a bit of a recovery, especially in US and Japanese markets. The German DAX has also started to show promising signs, suggesting that the multi-month rally in stocks is about to resume. In the last months of 2023, equity markets staged a sharp rally, fuelled by high expectations for a significant dovish shift by the Federal Reserve and other major central banks. However, at the turn of the year, some investors have expressed doubt about whether the anticipated rate cuts will align with the market's lofty expectations. Market expectations of up to 160 basis points in cuts this year, double the Fed's projection, have led some investors to reconsider their positions, reversing trades, or taking profits on long risk positions.

DAX technical outlook: key levels to watch

Source: TradingView.com

The DAX is continuing to consolidate its sharp gains made in the final months of 2023, so the technical outlook still looks quite bullish. The German benchmark stock index is currently residing inside a continuation pattern that looks like a bull flag. If it manages to break the resistance trend of this continuation pattern in the coming days, then it could go on to climb to a new record high, above the December high of 17004.

The underlying trend is bullish, with the index breaking several resistance levels in recent months. Most notably, it broke through the area shaded in blue on my chart in early December, where the highs of 2021, 2022 and the July 2023 peak all converge. Once strong resistance, this area has now turned into support. The DAX will need to continuing holding this 16285-16530 area in order to maintain its short-term bullish bias.

But if support doesn’t hold in the abovementioned 16285-16530 area, then this could pave the way for a deeper correction, with the next level of potential support not seen until around the 16000 area. This is not my base case scenario as things stand. 

-- Written by Fawad Razaqzada, Market Analyst

Follow Fawad on Twitter @Trader_F_R