The U.S. dollar may hold the key to whether this market rally can last

Published Fri, Jan 27 20231:15 PM ESTUpdated Fri, Jan 27 20233:06 PM EST

How stocks handle a bounce in the U.S. dollar could be a sign of strength for markets and hint that the January rally may last. The U.S. dollar surged in 2022, with the dollar index hitting a peak of 114.78 in September. At the same time, stocks have sold off due to the dollar strength, its impact on U.S. Treasury yields and what it may mean for companies with a global footprint. But since September, the dollar index has slipped and is now nearing a range that could lend support to the S & P 500 . "DXY is showing downside exhaustion based on weekly candle sessions, and it's into what should be long-term support around 100-102," Jonathan Krinsky of BTIG wrote in a note Thursday. "While we have our doubts, if the market is able to shrug off a dollar bounce in coming weeks, that would go a long way to the bull case." History shows how big moves in the dollar can impact the whole stock market. CNBC PRO looked at the five biggest monthly gains in the Dollar Index the last five years, and the S & P 500 posted significant losses in all but one of them. If the dollar does bounce and stocks hold onto recent gains, it may be a good sign that the rally has legs. The dollar index nearing 100 is a key level that many technical analysts are watching – it was named one of the big numbers for 2023 by Oppenheimer. When gauging the impact of commodities, currencies and interest rates on stocks, it's not always the strength or weakness of the asset but how stable each one is over time that matters, said Ari Wald of Oppenheimer. That's why the dollar settling at a round number and staying in range is important. "That inner market stability should create a bullish environment for the stock market in the coming months to quarters," he said. Of course, relying on historical correlations can be tricky as they do break at times, according to Katie Stockton, managing partner of Fairlead Strategies. Still, she's also been watching the dollar's major corrective phase and per DeMark Indicators sees an active signal on the dollar index that flashed on Jan. 13. .DXY 1Y line DXY YTD "What it suggests is that from the support area, we should see a relief rally or a dollar bounce," she said, adding that this would mark a sentiment shift around the dollar. If the dollar rises, positively correlated treasury yields will also likely get a lift, which could be a headwind for equities in the near-term. But, if the dollar bounces, yields rise and equities don't react negatively, that could be a good sign of strength, she added. "I would see that as a positive," Stockton said.