EURO CONTINUES TO REBOUND FROM IMPORTANT CHART SUPPORT -- IT'S BEING SUPPORTED BY RISING EUROZONE BOND YIELDS -- A WEAKER DOLLAR MAY BE GIVING A BOOST TO COPPER AND OIL -- ENERGY IS DAY'S STRONGEST SECTOR

EURO CONTINUES TO REBOUND FROM IMPORTANT CHART SUPPORT ... Global stocks fell on Tuesday May 29 on concerns that a new election in Italy might provide a threat to the eurozone. My message on the following day (May 30) wrote about global stocks starting to recover from that scare. Included in that message were a couple of charts showing that the euro was in a deeply oversold condition and testing a very important support level of its own. I suggested that a lot was riding on the eurozone currency holding above that support level. For one thing, a firmer euro would slow the advance in the U.S. dollar which had reached resistance near its November high (more on that shortly). Let's take another look at the euro itself. Chart 1 combines the two charts shown in that earlier message and shows why the current test of support is so important. The two circles show the late May bottom near 115 representing a test of its late 2017 low at the same level. The green horizontal line shows that the 115 level also represents a test of the euro's spring 2016 high at that level. A previous resistance level once broken should become a new support level. That's why the flat line turned from red to green once the 2016 high was exceeded in the middle of 2017. The 14-day RSI line (top box) also shows the euro starting to recover from a deeply oversold condition below 30. The euro has risen more than 2% over the past week to reach 118. The issue is still in doubt. But what the euro does from here could have a lot of important intermarket implications.

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Chart 1

THE DOLLAR INDEX BACKS OFF FROM NOVEMBER HIGH... The U.S. dollar has had a strong first half rally. But most of that rally came at the expense of the euro which accounts for 57% of the Dollar Index. And that index has reached a resistance barrier of its own. Chart 2 shows the U.S. Dollar Index (plotted through yesterday) backing off from a resistance line formed during the fourth quarter of last year near 95. It's down again today. The top box shows its 14-day RSI line backing off from a very overbought condition above 70. As is usually the case, Chart 2 is pretty much a mirror image of Chart 1. So what the euro does will largely determine what the dollar does. And what the dollar does really matters. For one thing, a weaker dollar could give a boost to commodity prices. We may already be seeing that in copper and oil which are bouncing again. For another, a weaker dollar could give a tailwind to large cap stocks which have fallen behind smaller stocks.

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Chart 2

SMALL CAP/ LARGE CAP RATIO LOOKS OVERBOUGHT ... Small cap stocks have done a lot better than large caps this year. That has had a lot to do with the rising dollar. The black line in Chart 3 plots a "ratio" of the S&P 600 Small Cap Index ($SML) divided by the S&P 500 Large Cap Index ($SPX). [I'm using the SML in this example because it's been the strongest small cap index]. Notice that the rise in the black line has coincided pretty closely with the rising Dollar Index (green area). Here's where it gets interesting. The ratio has risen to the highest level since the end of 2016. It's 14-day RSI line, however, is starting to stall near overbought territory at 70. That suggests that the premium of small caps over large caps has been stretched too far. That would suggest that large caps could start closing the gap between the two. A weaker dollar would contribute to that.

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Chart 3

SOME COMMODITIES ARE BOUNCING ... Commodities usually benefit from a weaker dollar. And some of them may be doing that this week. Chart 4 shows the Invesco Commodity Index (DBC) bouncing off support near its 50-day moving average. Most of today's buying is coming from the energy sector. Chart 5 shows the Invesco Energy ETF (DBE) also bouncing off its 50-day line. That's helping make energy today's strongest stock sector. Copper is also having a strong week. Chart 6 shows the price of the red metal (through yesterday) rising this week to the highest level in five months. A rising copper price often coincides with rising stock prices, and especially those tied to industrial metals and materials. Materials are also having a strong week and achieved a bullish breakout yesterday. This week's pullback in the dollar may be part of the reason why.

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Chart 4

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Chart 5

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Chart 6

ECB MAY START WINDING DOWN ITS BOND BUYING PROGRAM... One of the reasons the euro is bouncing may be the comment from the chief economist for the ECB that it may start scaling back its bond buying program as early as next week. That may explain why German bond yields are climbing this week faster than Treasury yields. The German 10-Year yield is up 2 basis points today while the 10-Year Treasury is down 4 bps. The premium of Treasury over German yields has been exacerbated by the fact that the Fed is tightening while Europe isn't. A more hawkish tilt in the eurozone could upset that relationship and begin to narrow that premium. That would most likely boost the euro against the dollar. Which brings us back to the testing process taking place in Charts 1 and 2. There's a lot riding on what the euro and dollar do from here. Dollar direction also has an important impact on foreign bonds, stocks, and currencies. That's especially true of emerging markets which have suffered the most from this year's dollar gains.