Euro / Dollar Movement and Its Connection With the Stock Markets

 |  Includes: ERO, EU, SPY
by: Vision Capital M.

The connection between the value of the Dollar against the Euro and the value of US stock markets is not direct and a weaker Dollar does not always mean higher stock prices at the same time. The idea that a rising Euro means rising stocks appeared only weeks ago when most of the people were struck by the great fall of stocks accompanied by the fall of Euro during the hype over the Greece crisis. In the last days it proved not to be so true as the Euro gained strength and the S&P 500 continued to fall.

I believe we could be in a situation where the downfall of US stock markets could continue for at least some more weeks accompanied by the start of a new rising trend of the Euro against the US Dollar. This means there is pretty much a chance the Euro will start to rise (or at least stop to fall) and it will take time before the stocks would follow that pattern. There are macro economical reasons for that as well as technical ones.

In one of my previous articles, part of the macro economical reasons were examined. The main point is that in a world-wide situation of short demand higher end costs could not ensure an easy selling of your goods. By "your" I mean American. So a stronger Dollar might be OK and look charming in a situation where everything blossoms but not doing much good to American companies in a stagnant world.

We shouldn't forget the notion of having the Dollar as a safe-haven for many investors and this explains its strength in the midst of the crisis.

The world is so interconnected that a strong America can't exist in a weak environment. And there are cycles. As the USA and Europe are on both ends of many trading channels, a weak Europe means no good for the USA. Big fluctuations in the values of their currencies ensure that both economies will get boosts in turns. With the idea of clearing the bad debts over time.

Since the beginning of 2010 we have been in a cycle of a strong Dollar. It hammered the exports of the USA for the first quarter of 2010 and it was only 5.8% higher than the previous quarter while the same figure for the forth quarter of 2009 was 22.8%. We should note that the 5.8 figure is still way better than the -29.9 reported for the first quarter of 2009. So the country could be recovering but the speed gets slower. During the forth quarter of 2009 the US Dollar has reached one of its lowest level (1.51) since the crisis began. Since then the Dollar has gained strength and the Euro has fallen. A contribution to the hard times for the economy are the higher prices of crude oil, which added pressure on the US consumers inside the country.

The fall of the Euro might continue for some more time but I believe we are approaching its end for now. Its fall has helped European economies to be more competitive against the US and China. And a weaker Euro ensures a cheaper clearing of debts. It also means the part of the IMF and particularly the USA money in the aid plan that Europe has agreed upon would cost less in Dollars. And when returned it could be priced much more if returned in a weak Dollar environment.

These were part of the macro economical reasons. The technical ones follow. Let's see these graphs.

click to enlarge

SPX and Euro/Usd graphsClick to enlarge

The left one is the movement of EUR/USD pair during the current crisis and the right one shows the movement of S&P 500 index.

What we see is that the fall of the S&P500 started before the growth of the Dollar. This is normal as at the beginning of the crisis not so many people were convinced there would be any big crisis at all. After that the safe-haven idea took the lead and the Dollar gained strength. Then the Fed intervened and poured a lot of Dollars on the market. The supply was enough to turn the price of the Dollars down. Some months later the markets hit bottom and the positive sentiment started to be built. It continued till the beginning of May 2010. The stimulus money had some effect and the companies presented spectacular results, especially the financial ones.

Since December 2009 however (almost 6 months before the current downfall of the stocks) the Dollar has been gaining strength again. The reasons could vary - starting from the safe-haven one (which is not very likely because everything looked shiny at that time) and getting to the simpler one of just pulling money out of the market when the big receivers of bailout Dollars paid their bills.

This leads us to the main conclusion that in general it's always a question of demand and supply. When the demand is exceeding the supply, the price goes up. So there are basically two ways to influence the price - change the demand or change the supply. In general economics the higher price attracts more producers which in turn increases the supply and stabilizes the price. It's almost the same in the stock and FOREX markets, with the main difference being that the role of producers is often taken by the Central banks, including the Fed.

We could very well be in a similar situation to the one we were before the stimulus actions of the US government took place. The lower inflation in the USA and the higher figures on the unemployment reported days ago just make a decision on leaving the low interest rates for a longer period easier to make. This could be a hit on the Dollar. If other stimulus packages or direct pouring of money (even in a form of easier access to funds) into the system happen to be needed in the face of the current macro situation in USA, this would be another reason for the Dollar to fall.

On the other side is the EU situation where today the lower house of German parliament approved the 750 billion Euro bailout plan Europe has agreed upon some days ago. Should the upper house approves it, this would pretty much mean the plan would pass and be accepted in the European countries. This would boost confidence on the Euro and provide the weaker Dollar with what is needed for the American economy to gain strength in its turn.

Speaking strictly technically, the graphs show more support for the Euro to start gaining strength than the S&P500 to stop its fall. Still, one should keep in mind that on the monthly graphs the Euro is in a negative trend and the S&P 500 in a positive one. There are some signs of divergences (more clearly visible on the weekly graphs) but it will take time before they get proven true or not.

Disclosure: No positions