Sensex will take cue from US dollar after euro package

All eyes are on Europe for the weekend announcement of the latest prescription to avert the sovereign debt crisis. The equity markets, meanwhile, gave mixed signals with the Indian, Japanese and Chinese markets falling, but the US markets rallying.

The US dollar is the best place to get a preview of how the equity markets will react to any announcement out of Europe over the weekend. The equity markets will be closed when the European authorities announce new steps to prevent the debt crisis. However, the foreign exchange market might be open based on the time of the announcement. The forex markets open around 2.30 am on Monday (Indian Standard Time) or 5 pm on Sunday, US East Coast time.

[caption id=“attachment_114343” align=“alignleft” width=“380” caption=“The US dollar is the best place to get a preview of how the equity markets will react to any announcement out of Europe over the weekend. Reuters”]  [/caption]

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Note that the dollar is a safety play, where investors rush to avert risk.Hence, if the dollar rallies, one can be sure that equities, which are risk plays, will sell off. One can also look at the euro-dollar currency pair. An increased risk aversion will also result in the fall of the euro.

The dollar index is near a support level of 76 that we had mentioned in previous articles. ( See Chart ). The index closed at 76.28 during the week. Remember that prices often rally from support levels. In case the 76 level is broken on the index the prices can drop down to the next support level near the 75.50 level. The fact that the dollar index is in such close proximity to support levels increases the chances of a rally.

The market has placed a lot of emphasis on the weekend announcement from Europe and is expecting a large (some expectations top $2 trillion) rescue package. A perceived smaller package can lead to disappointment, pushing up the dollar index and deflating equities.

Interestingly, the Indian, Japanese and Chinese markets don’t seem to be expecting much out of Europe. They have adhered to the resistance levels we had mentioned in last week’s article. Prices often fall from resistance areas.

For the Hang Seng index we had mentioned that the resistance level was around 5,300. It briefly went over the level last week only to close lower at 5,092 on Friday. For the Japanese Nikkei 225 index, the resistance level was around 8,870 and it closed at 8,678 on Friday, after going above the resistance level once last week.

In the case of the Sensex, the resistance level was at the 17,300 area and prices never reached that level and closed at 16,785 on Friday.

However, the US markets acted contrary to the other markets. The S&P 500 index had resistance in the range of 1,170 and 1,235 but closed above the range at 1,238 on Friday. Analysts are attributing the rally to strong corporate earnings in the US. But we’d never know if it was earnings or the hope of a grand package out of Europe that drove the index up.

It’s also important to note, as we mentioned in the article last week, that the S&P 500 has resistance slightly above at 1,265. Hence, a rally in the S&P 500 is likely to be stopped just a few points higher.

The conflicting signals given by the US markets, on the one hand, and the other markets makes forecasting difficult. Hence it’s best to wait for the announcement out of Europe, see the reaction of the dollar index and then trade the equity markets. Also remember that the US futures markets open on Sunday evening and one can watch those, too, to get an inkling of how the spot equity market will open.

George Albert is Editor, www.capturetrends.com