What would happen to the stock market if the U.S. dollar rallies?
It’s a question that isn’t getting much press, but investors may want to take a closer look. The fluctuations in the dollar can have a significant impact on the performance of individual stocks, certain sectors, and the market as a whole, so it pays to be aware of events in the currency markets at all times.
The year ahead, in particular, COULD prove to be a time in which currencies are a key factor in stock market performance.
A More Accomodating ECB Could Weaken the Euro
The U.S. Dollar Index (DXY) stands well below its 2001 peak, and it is largely unchanged from its level of six years ago. During this time frame, however, there have been a number of upward spikes: late 2008, early 2010, and 2011-2012. With the dollar having been relatively stable for two years, investors may be lulled into the expectation of continued currency stability.
That shouldn’t necessarily be the case. While the U.S. Federal Reserve’s quantitative easing has helped keep the dollar from establishing upside momentum against the basket of currencies represented in the index, this obscures what’s happening underneath the surface. The dollar has gained substantially against the yen on a year-to-date basis, as gauged by the loss of nearly 15% for the CurrencyShares Japanese Yen ETF (FXY).
The primary cause of dollar-yen strength has been the exceptionally aggressive monetary policy being employed by the Bank of Japan, which — as a percentage of the country’s economy — far exceeds the extent of the Fed’s quantitative easing.
Now, a similar dynamic may be set to unfold with respect to the euro.
The European Central Bank surprised the markets earlier this month by cutting rates and leaving open the possibility of employing negative interest rates to stave off deflation.
Ardo Hansson, a member of the European Central Bank Governing Council, was quoted by Bloomberg this week as saying:
“The options on rate cuts are still not fully exhausted and there are all kinds of other measures that are still on the table. Of course, every time you use one option, you have one less to use. But I don’t see us, by any means, running out of our toolkit of things we can draw on.”
The ECB’s more aggressive stance comes at a time in which the U.S. Federal Reserve continues to contemplate the possibility of tapering. While the estimates as to when a taper could actually begin are all over the map, the consensus is that the process could begin in the first half of 2014.