DAX index braces for a new normal as bond yields surge

European indices pulled back from their record highs after the rude shock by Jerome Powell, the Federal Reserve Chair. In Germany, the DAX index (DAX) pulled back to €15,565, which was a few points below its record high of €15,721. The same trend happened in other countries, with the CAC 40 and Stoxx 40 pulling back.

Rude wake-up call

German stocks pulled back modestly as investors suffered a rude wake-up call after a testimony by Jerome Powell, the Fed Chair. On his first day of testimony, he said that he remained concerned about runaway inflation. As a result, he believes that the bank will hike rates above the expected range in the coming months.

Global investors are now contemplating what the new normal will look like. Most importantly, they are assessing a situation where US interest rates will peak at about 65. If this happens, it will be the highest level the rates have been in more than a decade. In a note, Rick Rieder, who manages trillions for Blackrock said:

“We think there’s a reasonable chance that the Fed will have to bring the Fed Funds rate to 6%, and then keep it there for an extended period to slow the economy and get inflation down to near 2%.”

It will also be a new normal considering that the market has been accustomed to low-interest rates. After the Global Financial Crisis (GFC), most central banks, including the ECB, embraced an easy-money policy statement. 

Therefore, that new normal will likely see inflows into American bonds, which are doing relatively well. A rotation from stocks to bonds will likely have a negative implications for the DAX index. Coupled with a strong US dollar, we could see European investors move to US treasuries. The 2-year yield could hit 6% while the 10-year could jump to 5%.

DAX index forecast

DAX chart by TradingView

The DAX index jumped to a high of €15,656 this week and then pulled back. At its peak, the index was up by more than 31% from the lowest point in 2022. It remains above all moving averages. Also, the index is slightly above the key support level at €15,258, where it made some false breakouts recently.

The DAX has moved above the 50-day moving average. Therefore, in view of the changing macro situation. There is a likelihood that the bullish trend will take a breather, as investors target the key point at €15,258.