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Stocks Up Modestly; Stress Tests and Earnings Key Market Drivers Today

U.S. stock futures are up this morning and poised to challenge the recent tops, driven by demand for higher yields and better than expected earnings reports. Stocks received a boost for the second consecutive night after Europe reported favorable economic news.

The German based Ifo Institute reported the business-climate index rose to 106.2 in July from a reading of 101.8 in June. This number confirmed the strong recovery taking place in Germany and set the tone for a stronger Euro and a pick-up in demand for higher yielding assets.

The strong economic data from Europe this week is helping to renew confidence in a global economic recovery while the U.S. still struggles with the possibility of a double-dip recession. Traders have been punishing the Dollar late this week as the combination of dovish testimony from Fed Chairman Bernanke and robust economic news from Europe means interest rates will remain low in the U.S. while the Euro Zone grows closer to an interest rate hike. Investors, frustrated by the low returns offered by U.S. Treasury instruments are seeking better returns in equities, commodities and commodity-linked currencies.

Without any major economic reports today, investors will turn their focus early in the session to U.S. earnings reports then shift their interest to the European stress tests sometime around noon Eastern Time.

Investors are still questioning what the European stress tests will reveal. Some traders feel the tests may have been too soft to yield any significant results. Others expect the tests to show weakness in some banks especially in Spain and Greece. Overall, the tests will show that European banks need to raise capital.

Increased demand for risk is putting pressure on September Treasury Bonds after they reached a new high for the year earlier in the week. Although investors believe U.S. interest rates will remain low over the long-term, short-term the market appears to be overbought. Confidence in a global economic recovery is also pressuring T-Bonds as traders shed lower risk assets in favor of higher-yielding investments.

Thursday Recap

U.S. equity markets surged to the upside, taking back most of Wednesday's loss as signs of a global economic recovery helped drive up demand for higher risk assets.

Better than expected housing data and earnings reports also contributed to today's rally, but the majority of the buying was done overnight by aggressive Asian and European buyers.

Earlier in the week, Fed Chairman Bernanke helped drive the market lower with his dovish tone toward the economy. These losses were erased by a strong European industrial report. Today's rally sends a signal that investors are more optimistic in a global recovery than concerned about the possible double-dip recession in the U.S. Furthermore, with U.S. interest rates at extremely low levels and the strong possibility of more economic stimulus or quantitative easing by the Fed, traders feel that the stock market will offer a better return than fixed income instruments.

The U.S. Dollar fell sharply across the board on Thursday as trader demand for risky assets soared following a bullish economic report out of Europe last night. The release of a better-than expected Euro Zone industrial report combined with Bernanke's dovish testimony sent a signal to investors that the European Central Bank is moving closer to a possible rate hike while the Fed is still struggling with the possibility of a double-dip recession.

Furthermore, the bullish Euro Zone numbers are a sign that the ECB is likely to refrain from applying additional stimulus measures while the weakening U.S. economic data means the Fed is likely to consider a second round of quantitative easing.

The strong rise in the Euro spread to other currency markets as traders positioned themselves for a weaker U.S. economy. Traders demanded higher yielding assets as they anticipated the Fed leaving interest rates lower for a much longer period of time than previously estimated. U.S. Treasury Bond traders are currently pricing in the possibility of a Fed rate hike for September 2011. The bullish news about the Euro Zone and the dovish outlook for the U.S. economy is especially bullish for commodity-linked currencies.

The need for stimulus spending by the United States and the possibility of a global economic recovery means demand for raw materials is likely to increase. This should help Canada, Australia and New Zealand since their economies are driven by demand for commodities such as iron ore, copper and crude oil. While the Australian and New Zealand Dollars are surging to the upside, the Canadian Dollar is strengthening by remains in a range. The upward movement in the Canadian Dollar is most likely being limited by its ties to the U.S. economy.


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