FALLING RATES DON'T HELP EUROPE -- RISING COMMODITY PRICES HELP AUSSIE AND CANADIAN CURRENCIES -- AND RUSSIA

ECU LOWERS INTEREST RATES -- EUROPEAN STOCKS FALL... The European central bank lowered short-term rates a quarter of a point today. In the past, that might have boosted stocks. Not anymore. European stock markets sold off after the cut. As has been the case in the states for the past couple of years, falling interest rates usually result in falling stock prices. That's symptomatic of economic weakness -- and continuing problems with global deflation. It's a world-wide phenomemon. Germany, which is the largest economy in Europe, is also one of the region's weakest markets. Part of Europe's problem is a rising currency. A fifth of Germany's economy is based on exports -- which have been falling because of the rising Euro. Chart 2 shows the Euro rising over the past six-months -- and hitting a four-month high against the dollar yesterday.

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YEN IS RISING -- JAPAN ISN'T... While we're on the subject of rising currencies -- and weaker stock markets -- we thought we'd take another look at Japan, where global deflation problems surfaced in the first place. The Nikkei 225 Index has bounced off its October low four times over the past five months. Unfortunately, the intervening peaks still show a descending tendency. That gives the chart the appearance of a "descending triangle" where the lower line is flat and the upper line is declining. That's normally a bearish pattern -- and increases the odds that the Japanese downtrend will resume in time. The yen has actually been rising for the past year. While a rising yen might normally attract money to that country's market, it also hurts Japanese exports. A rising yen may actually serve to make Japan's deflationary problem even worse.

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THE RISING YEN... The next chart shows a potential "head and shoulders" bottom forming in the Japanese yen over the past two years. The yen is now approaching a challenge of the "neckline". The chart after that shows that the yen actually hit bottom five years ago -- during 1998. That raises some interesting questions. When a country is suffering through a deflationary period, the last thing it needs is a rising currency. [We suspect that's why the Fed has chosen to combat U.S. deflation by letting the U.S. dollar fall]. A rising yen would seem to make Japanese deflation even worse. It may also be worth noting that the decoupling of U.S. bonds and stocks occurred during 1998 -- right around the time that the yen bottomed and Asian deflation spread to the west.

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RUSSIA BENEFITING FROM RISING OIL... One of the few countries being helped by energy inflation is Russia. That's mainly due to rising oil prices -- and the fact that Russia produces a lot of oil. The Russia Moscow Times Index has just hit a new eight-month high and is a mirror image of most other global markets -- that are being hurt by rising oil prices. Two other countries that benefit from rising commodities are Australia and Canada.

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RISING COMMODITY CURRENCIES... Two foreign currencies that are linked to commodity prices are the Australian and Canadian dollars. That's because a large part of their economy is based on the production of natural resources. The chart of industrial material prices has formed two bottoms since 1997 -- one in early 1999 and bigger one a year ago. In both instances, the two commodity-based commodities rallied as well.

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AUSSIE AND CANADIAN ISHARES... The next two charts compare the iShares of the Australian and Canadian stock markets. These shares are priced in U.S. dollars, which makes them look stronger than than really are -- but is the correct way for American investors to look at them. Their rising relative strength lines (vs. the S&P 500) shows outperformance from both commodity-based stock markets over the past two years. Of the two markets, The Australia has been the stronger over the past two years. Canada raised their interest rates this week in an attempt to stem inflation arising from higher commodity prices. That should boost the Canadian dollar even further.

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AUSSIE AND CANADIAN STOCK INDEXES... The actual stock market benchmarks for both countries are shown below (quoted in local currencies). Their rising relative strength lines still show outperformance of the S&P 500 over the past year. Canada has been the stronger of the two. The Sydney All Ordinaries Index has just fallen to a new yearly low -- while the Canadian market is still well above last October's low.

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BOND YIELDS TESTING OCTOBER LOWS -- STOCKS ARE HEADED THERE... Back in the U.S., the 10-year T-note yield has now begun to challenge its October low. That's an important test. That's because bond yields and stock prices remain positively correlated -- which means that they're moving in the same direction. Any move into new lows by bond yields would be symptomatic of more economic weakness, which wouldn't be good for stocks. The final chart shows the S&P 500 on the verge of completing a bearish "pennant" formation and resuming its downtrend. That would put that U.S. benchmark on a lower trajectory toward its October low as well. As we saw in Europe earlier today, falling rates haven't been much help for stocks. In fact, falling rates have proven to be bearish for stocks.

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