Hot Topic - Can Stocks Rise When Dollar is Strong?

• Can Stocks Rise When Dollar is Strong?
• Euro Sees Strongest Rise in Over 20 Days
• CAD: Oil Drop to 6 Year Lows
• AUD Consolidates Ahead of RBA Minutes
• NZD Soars Despite Lower PMI Services
• Sterling Rebounds on Stronger U.S. Data

Hot Topic - Can Stocks Rise When Dollar is Strong?

One of the hot topics in the financial markets and on CNBC today is the question of whether stocks can continue to rally with a rising U.S. dollar and it could not come at a better time with the wrap up of fourth earnings. In Q4, many big names like P&G, Google, IBM, and McDonalds have said a strong dollar stifled earnings and with the dollar index appreciating more than 10% between January and mid March, the main concern is that Q1 earnings will take an even bigger hit. For an individual company or sector, the impact of the dollar can be significant both directly and indirectly (through the changes in commodity prices and other factors) but for the S&P 500 as a whole, the following chart shows that a rising dollar has very little impact immediate impact on stocks.  In fact, a now well circulated study by Goldman Sachs found that the S&P 500 index is indifferent to FX moves.  Since 1981, the median annualized return of the index was nearly identical in both strong and weak U.S. dollar cycles and similarly on a 1 year basis, they found the daily correlation of the dollar and stocks to be zero.  This indicates that many multi-national companies do fine when the dollar is strong because a strong dollar makes raw material imports cheaper and helps to preserve margins. 

But many investors are wondering if the current market environment is different because the Federal Reserve is preparing to raise interest rates.  Borrowing a line from the Brits, stocks won't crash if the Fed opts for a gentle rise in rates.  Taking a look at the last 15 times the Federal Reserve raised interest rates after keeping them on hold for some time, the S&P 500 rose on average 0.8% one month after the first hike.  The worst sell-off was in 1999 when stocks fell 3.2%, which was a steep but short-lived decline because 12 months later, the index was up 6%.  As long as U.S. data continues to improve providing support for current and future earnings expectations, stocks can still rise. This last stipulation is one the Federal Reserve will need to keep in mind if they want to prevent a crash in equities when they start raising rates. In order to maintain steady earnings expectations, the central bank will need to ensure that rates will not be rising quickly and aggressively - a point we expect Yellen to stress at this week's FOMC meeting.  

Euro Sees Strongest Rise in Over 20 Days

After dropping to a fresh 12 year low during the early Asian trading session, EUR/USD reversed sharply rising by the strongest amount in 20 trading days. No Eurozone economic reports were released today but softer U.S. data drove the U.S. dollar lower against most of the major currencies.  According to the Empire State manufacturing survey and NAHB housing market reports, the recovery in the U.S. economy lost momentum in the month of March. This led investors to wonder if the Fed will signal patience at this week's meeting (more on this tomorrow).  EUR/USD traders were also disappointed that the ECB did not buy more bonds last week as part of its Quantitative Easing program. According to the central bank, they bought 9.751 billion euros, which is less than the amount that they need to buy on a weekly basis to achieve their 60 billion euro a month target.  This raised concerns that there are not enough sellers which is perceived to be euro positive because less money is injected into the economy.  The currency also benefitted from the latest comments from ECB President Draghi who noted the signs of a sustained recovering taking hold in the region's economy.  The German ZEW survey is scheduled for release tomorrow and between Draghi's optimistic outlook, the positive implications of QE and stronger German data, we expect an improvement in investor confidence that could drive EUR/USD above 1.0650.

CAD: Oil Drop to 6 Year Lows

The decline in commodity prices prevented the Canadian and Australian dollars from trading higher against the greenback today. Oil prices dropped to its lowest level in 6 years on rising inventories and signs of a possible nuclear deal with Iran that could allow for the sale of Iranian oil to the global market. This was the lowest price for oil since March 2009 and raises the risk of a move below $40 a barrel.  There's no doubt that central bankers around the world are watching the move in oil closely because a break below $40 would lower inflation expectations and either add pressure on central banks thinking about easing or slow others from tightening. Gold prices also declined slightly but the upcoming RBA minutes are the main reason for the consolidative price action in Aussie.  The last time we heard from the central bank, they left rates unchanged and said that further easing may be appropriate in the months ahead which meant that they are still inclined to lower interest rates.  The minutes will most likely reinforce their dovish bias and reinvigorate the decline in the Australian dollar. Finally, the New Zealand dollar traded sharply higher against the greenback despite a slowdown in service sector activity.

Sterling Rebounds on Stronger U.S. Data

Like the euro, sterling rebounded against the U.S. dollar today.  House prices grew at a slower pace according to Rightmove but the market ignored the news choosing instead to focus on weaker U.S. data. This week will be an important one for sterling because Bank of England Governor Carney's recent comments have left investors thoroughly confused. On one hand he has been talking about gentle rate rises and on the other he expressed concerns about sterling strength. The BoE minutes will shed light on where the monetary policy committee as a whole stands and how likely rates will rise this year.  We believe there's more upside than downside risks to this week's U.K. event risks but given that the minutes and employment report will be released on the same day as the FOMC minutes, the price action of GBP/USD could be dominated by U.S. dollar flows.  For a purer sterling bet, its best to look at the crosses.