DE30

If the DAX can hold current support levels before breaking to new cycle highs, it could reaffirm the strength of its bullish channel.

There’s significant political risks facing the Eurozone in the coming months, which may also help to keep a lid on the European stock markets.

A number of European stock indices have broken out above their recent ranges, most notably Germany’s DAX index which was up a good 1.5% at 10950 at the time of this writing. Sentiment towards European stock markets have turned positive in recent times due, in part, to speculation about a state bailout for Italy’s troubled banking sector, while energy-linked stocks have surged after the OPEC-inspired rally in oil prices, though both crude contracts have struggled so far this week.

It may be a quiet day in terms of economic data, but there’s been plenty of political news in mainland Europe which has impacted both the euro and stocks.

European stocks have started Tuesday’s session on the front foot after a lacklustre performance on Monday. Sentiment remains upbeat for global equities mainly because of the actions of central banks, rebounding oil prices and the mostly better-than-expected US corporate earnings results.

The contrast between European and US equities could not be more striking. Whereas the S&P 500 is just shy of its all-time high, in Europe, most major stock indices are still limping following their early 2016 wobble. This is despite the ECB’s on-going bond buying programme is at full throttle, which has helped to push benchmark government bond yields to record lows with the German 10-year being just above zero and UK’s equivalent dropping to a fresh low today.

Stocks found some much-needed support this week on the back of a rising oil price to $50 a barrel and as concerns about the negative impact of a potential June Federal Reserve rate increase diminished. Traders realised that a small rate rise, if seen, would not materially impact the world’s largest economy where monetary policy remains exceptionally accommodative. Other major central banks such as the European Central Bank and the Bank of Japan are providing the monetary stimulus the Fed once used to, anyway. These central banks, unlike the Fed, remain pretty much dovish. In fact, the BOJ is widely expected to expand its QE programme at some stage this summer. The ECB, having announced an extension back in March, is unlikely to make further changes in QE when it meets next week. After all, the ECB will start purchasing corporate bonds next month. So expect to see some “wait and see” inaction from the ECB in the coming months. The ECB’s policy is aimed at driving yield-seeking investors out of fixed income and into higher-yielding assets, like equities. For this reason, we continue to remain bullish on stocks.

European stock indices have enjoyed a short-covering bounce that began late in the day on Thursday when Wall Street shares managed to erase most of their earlier declines. At midday in London, the UK’s FTSE 100 was up 1.2% and Germany’s DAX was 0.7% higher.

European stock indices were trading lower at the time of this writing, in what has been a very bad week for equities.  Understandably traders are awaiting the key monthly US jobs report in approximately half an hour from now to provide some direction. Although a stronger-than-expected set of numbers could bring forward expectations about the next Federal Reserve rate increase to as early as June, which can actually be bad news for stocks in the short-term, it would nonetheless help to reduce some concerns about the health of the world’s largest economy. Conversely, a significantly weaker set of data may put to bed talks of a rate increase in June once and for all. So we may see some wild price action in stocks initially before the markets make a decisive move later in the afternoon.

This week’s inaction from two major central banks, namely the US Federal Reserve and the Bank of Japan, has caused the global equity indices – Japan’s Nikkei, in particular – and the US dollar to weaken as the yen and safe haven precious metals soared.  On top of this, weakness in US data persisted as fresh data showed the world’s largest economy grew only by 0.5% in the first quarter on an annualised format, which was less than expected. Japan’s economy fell back into deflation and household spending there slumped more than 5% in March compared to the same period in 2015. Meanwhile in Europe, the UK economy grew by a meagre 0.4% in the first quarter, although this was in line with the forecasts, while the Eurozone GDP expanded by a better-than-expected 0.6% in the first three months of the year. However, inflation was a weak point in the Eurozone as CPI fell back below zero, printing -0.2% year-over-year for April. Along with precious metals, oil prices repeatedly surged to new 2016 highs on the back of a weaker dollar and signs of a more balanced oil market on dwindling US crude production. So, commodity stocks outperformed globally.

European stock markets are trading lower at the time of this writing. Sentiment has been hurt by the weaker oil and commodity prices which have weighed heavily on miners. In addition, the inaction by the Bank of Japan overnight has encouraged speculators to book some profit on their long positions opened post the ECB’s decision to expand QE last Thursday. It is also likely that some traders are simply sitting on their hands as they await the FOMC policy statement and Janet Yellen’s press conference on Wednesday. The Fed is highly unlikely to cut interest rates at this meeting, but the market is wary of potentially hawkish remarks that would suggest a June rate rise is firmly back on the table. This scenario would probably cause US markets to fall, at least initially anyway. But in the event that the Fed sounds more dovish than expected, stocks are likely to stage a relief rally.

European stocks have stormed back to life this morning, evidently in anticipation that the European Central Bank will ease its policy further as it attempts to boost growth and create inflation in an economy which is lacking on both fronts. Traders need to be wary of the possibility that the ECB may disappoint again, like it did back in December. Then, it merely cut rates into the negative when the market was expecting the central bank to do at least that and also expand its asset purchases programme. This time, analysts are once again calling for an increase in monthly purchases to the tune of €10 billion per month and perhaps extending the duration of the programme by six months. So, QE is expected to rise to €70 billion per month and run until September 2017. But with oil prices coming back strongly and the euro remaining weak, the ECB may once again hold off fire. This potential scenario would likely disappoint the markets and lead to a sharp sell-off.

The European stock markets started the new week and the last day of February on the back foot this morning. The kick-back rally had actually fizzled at the end of last week when oil prices also retreated from their recent highs due in part to profit-taking, while at the weekend, the G20 meeting ended with few surprises. News that German retail sales grew by an above-forecast 0.7 per cent month-over-month in January was offset by data showing a sharp 1.5% drop in import prices. Then at 10:00 GMT this morning, stocks jumped on the back of news the People’s Bank of China (PBoC) has cut banks' reserve requirement ratio by an additional 50 basis points. At the same time, fresh inflation data showed consumer prices in the Eurozone unexpectedly fell by 0.2% year-over-year in February, which raised the probability we may see the introduction of further monetary stimulus from ECB next month.

But for now, the sellers remain in control and the bear trend is getting stronger with each key level of support breaking down. At the time of this writing, the DAX was testing another important support around the 9000-9035 area. The lower end of this range is a psychologically-important level while the upper end marks the 38.2% Fibonacci retracement of the entire 2009-2015 upswing. It is possible the index may stage at least a short-term rally from here. Below 9000, there are a couple of shorter-term Fibonacci extension levels to watch at 8840 and 8720, as shown on the chart; then not much further reference points are seen until the 2014 low of 8350.

In a quick follow-up to our DAX report published on Friday, the German benchmark stock index is currently displaying a bearish technical pattern on its intraday charts, which points to further losses in the near term.

The impact of the Bank of Japan’s surprise move to cut interest rates into the negative was swift overnight as the Nikkei led a global stock market rally. This ensured that at least in Japan, stocks would close significantly off the recent lows. But this has nevertheless been the worst ever start to a year for global stocks. Money managers may therefore decide to significantly reduce their equity holdings as they rebalance their portfolios ahead of the new month. They don’t want to be stuck with equities should they fall further in February. So, the last trading day of this month may end how it began: lower. Added to this, the impact of Amazon’s big drop following its earnings release may deter US investors from buying the so-called “FANGs” group of stocks which was largely the reason why US indices did not fall significantly in 2015.