DOLLAR INDEX REACHES 12-YEAR HIGH AS EURO TUMBLES -- USD BREAKS 30-YEAR RESISTANCE LINE -- WIDENING SPREAD BETWEEN 10-YEAR TREASURY AND GERMAN YIELD IS SUPPORTING DOLLAR RALLY -- FOREIGN CURRENCIES ARE ALL FALLING
DOLLAR INDEX REACHES 12-YEAR HIGH AS EURO PLUNGES... A lot of attention is being focused on the continuing surge in the U.S. Dollar, and the plunge in the Euro. The monthly bars in Chart 1 show the U.S. Dollar Index (green bars) rising to the highest level since 2003, while the Euro (blue line) has also fallen to the lowest level in twelve years. It's a little surprising that so much attention is being drawn to these trends, since they started in the middle of last year and accelerated near year's end. The USD hit a four year high last September, and an eight-year high in December. The Euro fell to a ten-year low in January. And there's no sign of those trends stopping or reversing. In fact, the longer-range of the dollar looks even more bullish. The monthly bars in Chart 2 show the USD rising above a 30-year declining resistance line drawn over its 1985/2002 peaks. That suggests that the dollar is still in the early stages of a secular uptrend. The main reason for the diverging currency trends is divergent monetary policy between the U.S. and Europe.
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Chart 1
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Chart 2
SPREAD BETWEEN U.S. AND GERMAN YIELDS SURGES... Currency values are usually determined by the level and direction of interest rates between one country and another. The country with higher (or rising) interest rates will usually have a stronger currency than a country with lower (or declining) rates. At present, eurozone bond yields are falling to record lows while Treasury yields are not only much higher, but are bouncing. The two lines in Chart 3 show the increasing divergence between the 10-Year Treasury yield (green line) and the 10-Year German bund (blue line). The 10-year yield hit 2.24% on Friday (after a strong jobs report). Meanwhile, the 10-Year German yield fell yesterday to 0.24% which is the lowest yield on record. [That drop pulled U.S. yields lower on the day]. The rising line on top of Chart 4 shows that the spread (or difference) between the two yields has been rising since last spring (and has now reached the widest level in 25 years). That set the stage for the dollar rally and is keeping it going. The green circle to the upper right shows the U.S.-German yield spread jumping sharply since mid-January when the ECB announced its new QE bond-buying program. This Monday's launch of eurozone bond-buying has pushed most eurozone bonds to record lows, with shorter maturities in negative territory (below zero). That followed a jump in U.S. bond yields last week. That's why the dollar is surging and the Euro tumbling.
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Chart 3
CURRENCY RACE TO THE BOTTOM ... The dollar is rallying against all major foreign currencies. Chart 4 shows shows foreign currency losers since the start of the year to be the Euro (-12%), Canadian Dollar (-9%), Australian Dollar (-7%), British Pound (-4%), and the Japanese yen (-1%). Emerging currencies as a whole are down -4%. Several individual emerging currencies, however, have fallen to the lowest levels in years (like the Brazil Real which is down nearly -13%). Commodity-related currencies are being hurt especially hard by the dollar rally. That includes Australia, Canada, Brazil, and Russia. That's because the rising dollar keeps commodity prices under pressure. Emerging market stocks are being hit harder than foreign developed markets. Quantitative easing in the eurozone and Japan is boosting their stocks quoted in local currencies. It's necessary, however, for American investors to hedge out the negative impact of weaker currencies.
Chart 4
RISING DOLLAR FAVORS SMALL CAPS... One of the side-effects of a rising dollar is that it favors small cap U.S. stocks over large multinationals. That's because small cap businesses are more oriented to the stronger domestic U.S. economy. By contrast, large cap multinationals are more exposed to weaker foreign economies. Nearly half of last year's profits for stocks in the S&P 500 came from foreign markets. That may explain why smaller stocks are holding up better during the current market pullback. Chart 5 shows the Russell 2000 Small Cap Index ($RUT) testing support at its (blue) 50-day average and initial chart support along its January peak near 1200. [The S&P 500 Large Cap Index has slipped below its 50-day line]. The solid line on top of Chart 5 plots a small cap/large cap ratio which has been rising since last October. It is currently at a new eight-month high. That confirms that smaller stocks in the U.S. are doing better than large caps.
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Chart 5
FTSE ALL-WORLD INDEX TESTS TRENDLINE SUPPORT... Last Wedneday's message showed the FTSE All World Index ($FAX) backing off from overhead resistance from peaks formed last July and September. [The $FAW includes stocks in 47 countries (including the U.S.), from both developed and emerging countries]. It has lost more ground since then. Chart 6, however, shows the global stock index trying to find support at a rising support line drawn under its October/January lows (green arrows). That's an important test for the global uptrend.
