U.S. Dollar Holds Support, Stocks Come Back to Life - Fed, ECB Coming Up

U.S. Dollar, SPX, EUR/USD Talking Points:

• It’s been a massive start to the week for volatility as VIX showed its second flare over the 20-handle so far this year.
• The first was January 13^th, right around when the election gap had filled in SPX. The second showed yesterday and was widely-attributed to the fervor around the DeepSeek AI model out of China.
• That narrative didn’t seem to fit entirely, however, as there was also fear of Yen carry trades unwinding after last week’s BoJ rate hike. And, paradoxically, this could denote how a dovish FOMC might compel selling in stocks, as further fears of unwind could cause de-leveraging across risk assets. And as a case in point to that, as the U.S. Dollar and USD/JPY have put in bounces so far today, U.S. equities have continued to rally from yesterday’s lows.

Video

A big week remains ahead of us with both the Federal Reserve rate decision and the Core PCE data release for Friday. There’s also rate decisions out of Canada and Europe to contend with, to go along with a host of important earnings announcements from Tesla, Meta and Microsoft on Wednesday, after the Fed, and Apple on Thursday.

That heavy calendar could be a likely reason for some position-squaring at the early part of the week but the sell-offs that showed in equities yesterday were widely-attributed to the DeepSeek AI model out of China, which ‘threatened’ to up-end American efforts at AI advancement. It wasn’t even a week before that SPX gapped-higher the day after the announcement of the Stargate initiative, in which Softbank’s Masayoshi Son pledged a half a trillion U.S. dollars (yes, $500 billion) towards continued build-out of infrastructure for Artificial Intelligence.

That gap was gapped-through again on the weekly open, with SPX starting the week below the 6k handle. But, as I wrote earlier yesterday, the VIX spike above 20 had already started to recede, and recovery themes were very much in focus. A day later and bulls are back in a big way. The stargate gap that was then engulfed by the the DeepSeek gap hasn’t yet been completed, but on the below chart we can see where bulls have less than 10 points left before that’s the case.

For overhead resistance, 6100 is still problematic for longs as bulls couldn’t make much headway beyond that price last week, even when momentum was strongly tilted to the upside.

Indices Forecast

SPX Daily Price Chart

U.S. Dollar Support

In the video linked above for today’s webinar, I made a case where the more desirable outcome for equity gains is likely stability in the U.S. Dollar, because if the USD was selling off quickly, there could be fresh fears of USD/JPY carry unwind which, like we saw last year, can fast turn into a global de-leveraging event and that could certainly hit stock prices in the U.S. I had talked about this in yesterday’s article and video, as well, highlighting a key support test taking place in DXY at the time.

So far, that support has held at 107.35 and a bounce has transpired. This goes along with a bounce in USD/JPY and that’s going along with a strong bounce in stocks, such as we can see above.

U.S. Dollar Weekly Price Chart

USD/JPY

The Tokyo inflation report for this Thursday is suddenly more important after last week’s rate hike. Japanese inflation printed at a whopping 3.6% last week against a 2.9% expectation, and that illustrated a climb from the prior two months from 2.3% to 2.9% to the 3.6% that was released last week.

Given how quickly Yen-weakness priced-in last quarter, it makes sense that some of that inflation roots from currency weakness, but this Thursday we will get CPI data out of Tokyo and that’s similarly been on an upward trajectory, from 1.8% released in October to 2.6% in November and then 3.0% in December. If this comes out hot there could be further fears of Japanese inflation heating up, which could increase Japanese rate hike expectations – and that could further compel unwind of the carry trade that made a dent in global markets last year.

It was last July when the Bank of Japan intervened to defend the 160.00 level in USD/JPY, on the same morning of a below-expected CPI print out of the U.S., and that kickstarted a round of volatility that lasted for the next three weeks and erased trillions in global market cap. As USD/JPY found support above and around the 140.00 level in August and September, policymakers suddenly sounded not-so-dovish, and that helped the pair to recover in Q4 as the U.S. Dollar came back to life.

Last week saw the BoJ hike rates to 0.5% and the initial reaction was a support test in USD/JPY followed by a bounce. But after this week’s open, the equity sell-off went along side a slide in the USD/JPY to a fresh monthly low.

This may actually be a larger risk factor for stocks than the DeepSeek AI model that got all the headline attention yesterday morning.

For now, USD/JPY has bounced so far today along with USD holding that support at prior resistance. IF the pair can continue to mount an incline, this could be seen as keeping de-leveraging at bay, because what is the carry trade, after all, if not another form of leverage across global asset markets.

But – if we see the pair sell-off aggressively, and the spot that I’m watching for this theme is the same 150-151.95 zone – there could be ramifications across global markets as that leverage comes off.

USD/JPY Daily Price Chart

EUR/USD

Not to get lost in the shuffle but there is an ECB rate decision on Thursday morning, after the Wednesday fireworks, and the bank is widely-expected to cut rates again. EUR/USD has been rallying for the past two weeks however, following a support test at a major spot around the 1.0200 handle.

As shared in the webinar, this can still be tracked as bullish given the higher-highs and lows that have pushed for the past couple of weeks, but the daily chart is currently brewing a not-yet-completed evening star pattern, often followed with aim of bearish reversal. The fact that this formation has built right at the 1.0500 handle, which previously helped to mark the lows of range support, makes it all the more enticing for directional plays.

At this point, there’s a spot of support-turned-resistance from around 1.0333-1.0344 that’s of interest, and if bears can sink price below that level, 1.0200 is vulnerable.

EUR/USD Daily Price Chart

--- written by James Stanley, Senior Strategist