The dollar index may hold the key for stocks

by Michael Tarsala, CMT

The currency markets -- which tend to lead stock markets -- are not doing S&P 500 bulls many favors right now.

The reason to watch currencies and not just stock charts is well known: A weaker dollar is inflationary, and tends to push stock prices higher. A stronger dollar is deflationary, and it tends to push stock prices lower.

Some analysts add that currencies tend to lead stock markets at major turns.

Raymond James strategist Jeffrey Saut calls the dollar index, seen below, “the most important chart in the world”.

Source: Stockcharts.com 

You can see, it's been moving sideways, but on the rise within that sideways pattern since late April. Part of the recent gain is on the dollar's strength relative to European currencies, amid new turmoil in Greece.

A continued rise above the top blue line would mark a new uptrend. That would tend to put more pressure on equity markets.

A breakout is not in any way a given, and not necessarily expected. The dollar index has rallied up near the top blue line on two other occasions, only to continue moving sideways.

For his part, Saut sees the pattern eventually breaking to the downside. Part of his logic is that the Fed wants a weaker dollar, to keep a whiff of inflation in the economy, and to pay U.S. debt more cheaply.

That said, it's awfully close to that top line, which bears watching right now.

Keep an eye on it either way. A breakout could spell trouble for equities. And a continuation or a breakdown could help the stock market bulls.

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