USD Strength, EUR Weakness Means US is the Place to Invest

USD Strength, EUR Weakness Means US is the Place to Invest

$USD, $EUR

FLASH: The Fed has pivoted to a Dovish policy, yet that does not appear to have stopped USD.

The US Dollar (.DXY) Index, which measures the value of the Buck Vs a basket of 6 peer currencies, just hit a 2month-high, which also happens to be close to a 2-year high.

The strength of USD has come largely at the expense of the EUR, which has a 57.6% weight in that index. No other currency is even close. The Japanese yen, with a 13.6% weight, is the second most-heavily weighted currency in the .DXY.

The disproportionate weighting is one reason why economists, and the Fed prefer to look at the Federal Reserve’s Broad Effective Exchange Rate Index to gauge what effects currency swings might have on economic activity.

The latter point notwithstanding, the leaning of the US Dollar Index is still informative, particularly at this time as it conveys a picture of relative weakness for the Eurozone economy that has been painted in broad brush strokes by weak data.

Growing Pains

The weakness in the Eurozone has availed itself in recent months, yet it came together in a collective fashion with the release this week of preliminary Q-4 GDP data. The broader Eurozone economy managed a 0.2% Q-Q increase that matched its weak 3rd Quarter performance.

Germany, meanwhile, reported a preliminary 0.0% Q-Q change in GDP that came on the heels of a 0.2% Q-Q decline for Q-3 GDP. That is not much to cheer about, unless one wants to relish the thought that the German economy escaped falling into the grip of a technical recession, which is defined as 2 consecutive Quarters of negative GDP growth.

It’s little wonder that EUR has been flagging along with the Eurozone economy. The support structure of a strong economy is not there, which means, consequently, that the European Central Bank cannot, and will not raise its Key interest rates anytime soon.

Dollar Days

That very-low, and negative, interest rate complex is an albatross around the neck of EUR and a talisman for USD, which has been afforded its strong position by the relative strength of the US economy and a higher interest rate complex.

The understanding today that the Fed is going to be patient before making its next interest rate move hasn’t counted against the dollar to any great extent, because:

  • The US economy is still growing faster than many other developed economies.
  • Interest rates here are still much higher than they are in Western Europe and Japan.
  • The US stock market is still outperforming.
  • The US is still a great place to invest given its relative political stability, rule of law, industry leadership, and liquid capital markets.

The strength of USD has consequences, though, some that are good and some not so good.

The good consequences include the following:

  • It helps hold down inflation, as it makes the cost of imported goods less expensive and applies pressure to dollar-denominated commodity prices.
  • It makes it more affordable for US citizens to travel abroad.
  • It raises the appeal of owning US assets, which attracts foreign capital and improves growth prospects.

The not so good consequences include the following:

  • It makes it more expensive for foreign holders of dollar-denominated debt to repay that debt.
  • It can lead to capital flight that spurs volatility in emerging markets and a possible contagion effect.
  • It creates competitive pressure for US exporters.
  • It crimps earnings prospects for US multinational companies.

Both the Treasury market and the stock market have appreciated the implications of a stronger USD on the inflation front. The tie that has bound both markets is the recognition that low inflation will keep the Fed from raising interest rates.

The stock market cannot ignore the fact that the strong USD is an earnings headwind for companies doing business outside the United States. It is an added headwind considering weaker demand abroad will result in reduced sales activity.

What It Means: The stock market and Treasury market are marching to the same beat, as it is becoming increasingly apparent why market rates have barely budged in the face of an epic stock market rally.

The strong USD is the tell, and what the EUS is screaming that the Eurozone isn’t in a good economic spot now, and will not be again soon.

That assessment was validated by ECB board member Benoit Coeure Friday when he acknowledged, according to Reuters, that a new targeted refinancing operation for Eurozone lenders is possible and being discussed. Mr. Coeure said so on the back of an admission that the slowdown in the Eurozone is more pronounced than previously expected, which is likely to lead to a shallower path of inflation; meaning advantage USD.

The strength in USD will contribute to downward earnings revisions, which could concern investors at some point, but not now because the US economy is not showing signs of flagging like the Eurozone economy is

And the stock market is not being upended by USD’s strength so much as it is being supported by the Euro’s weakness, which is a reminder that the US is a good place to invest.

Have a terrific week

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Paul Ebeling

Paul A. Ebeling, polymath, excels in diverse fields of knowledge. Pattern Recognition Analyst in Equities, Commodities and Foreign Exchange and author of “The Red Roadmaster’s Technical Report” on the US Major Market Indices™, a highly regarded, weekly financial market letter, he is also a philosopher, issuing insights on a wide range of subjects to a following of over 250,000 cohorts. An international audience of opinion makers, business leaders, and global organizations recognizes Ebeling as an expert.

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