It's no secret that currencies play a huge role in setting the direction of the market, or at least it shouldn't be to anyone who reads this blog. Currency fluctuations are a powerful force. They exert an inflationary pressure on stocks and give us a clue to the market's overall appetite for risk at any given time.
Considering this, have a look at the charts below. One is of the the Euro and the other is the US dollar. If you compare them to the market indices, you'll notice that something is amiss. The markets rallied on Friday with an unrelenting fury, while the world's two major currencies hardly budged. When I'm faced with an incongruity like this I rely on whichever side I believe has the most credibility. Currency markets remain active and liquid even when equity markets do not, so I trust what they tell me.
The Euro generally trades inverse to the USD so we would expect it to mirror the markets--this was certainly not the case on Friday. FXE (the Euro) ended the day positive by just 0.18%, far under-performing the S&P's rally. The blue down sloping trend-line will remain resistance, at least for the short term. The series of lower highs since early May is also a bearish sign. For me to have faith in a continued S&P rally, the FXE will need to get above the blue trend-line and these previous pivot highs.
The US dollar had a similar Friday to the Euro with UUP closing down just 0.09%. UUP will have support at the as-of-yet untouched up sloping blue trend-line. Any bounce in the UUP will put pressure on stocks and stock indices like the S&P. Bulls should be discouraged by the fact that the US dollar showed little signs of breaking down in spite of a huge rally in stocks.
Irregardless of how currencies perform we need to respect price action, so I won't just discount Friday's stock rally out of hand. What I will say though is that the prospect of a continued rally next week is tentative at best without the support of major currencies. I'll be watching both the US dollar and the Euro closely before trading resumes next week as they will be the key to the markets. Check back here and follow me on twitter for my latest thoughts.