German DAX – Mind the weekly double bottom

DAX - US Dollar Index Correlation
DAX – US Dollar Index Correlation

From the update on German DAX a few weeks ago, the index which was trading at 10009 managed to turn around from the lows to close last Friday at 10188.4. The equity index was supported by the fact that the ECB had signaled its willingness to expand the sovereign bond purchases. Although nothing was confirmed, the fact that the option is now on the table has been supportive for the German DAX Index. It remains to be seen if indeed the ECB will expand its balance sheet and of course, it all depends on how the Eurozone data continues henceforth. So far, the markets were surprised with a pickup in the Eurozone GDP which increased to 0.4% for the second quarter, beating estimates. However, inflationary pressures remain to the downside especially in light of Crude Oil prices being forecasted to decline in the coming years.

The main risk to the German DAX and the equity markets in general will be this week’s FOMC interest rate decision. The consensus is finely split between a 50% probability of a rate hike although the futures markets imply a 28% probability for the Fed to hike rates. The reason that we look to the Fed’s decision is the fact that the US Dollar Index has shown a strong correlation to the German DAX index as shown in the chart below.

DAX – Technical Analysis

German DAX - Weekly Chart Double Bottom
German DAX – Weekly Chart Double Bottom

Price action declined to 10022 level of support and has so far managed to hold prices on three tests to the support level so far. The decline to 10022 comes in light of the descending triangle pattern that was formed, which gave an estimated projected target to 10170.6 level. On the weekly charts, the German DAX Index has formed a near double bottom pattern which could be bullish considering that the RSI has made a higher low. This could potentially point to an upside rally to 10473, in the event the double bottom pattern is valid on break out above 10302.5

An interesting observation here comes when looking at the daily charts, where price action has consolidated into a bearish flag pattern. Even while assuming that the weekly double bottom pattern would be valid, a rally to 10473 still fits in with the bearish flag pattern. Only a daily close above 10473 would invalidate the bear flag and open up the way for the German DAX to possibly test the previously broken support of the descending triangle at 11016.2. In the event that the bear flag pattern does indeed get validated, we could possibly expect a sharper decline to as low as 9062 and eventually to 8368. Of course the main support at 9609 will be an important barrier in the eventual decline lower.

German DAX - Daily Chart Bear Flag
German DAX – Daily Chart Bear Flag

From the above and taking into consideration the fact that we see a strong correlation between the US Dollar Index, there is a high probability that we could see the Greenback decline in the near term as well as the equity markets coming under pressure during the week or next couple of weeks.