Idea of the Day why the US indices are not immune to the falling dollar

What: As the Dow threatens to break 22,000 today after the strong set of Apple results overnight, it is easy to dismiss the decline in the dollar as a purely FX-related incident that doesn’t have any bearing on the US stock market. However, that is not the whole story, and the recent rise in the euro could start to impact US stocks in the coming weeks.

If you look at the S&P 500 priced in euros, see chart 1, then it has actually fallen 8% since reaching a peak back in February. It’s a similar picture for the Dow Jones, which is down 7.8% in euro terms since peaking at the start of March.

How: This can have a couple of consequences for the direction of US stocks in the coming weeks: firstly, if the euro continues to rise then returns on US equities will diminish for investors based in Europe whose $ profits from US stocks need to be converted into the single currency. This could reduce the attractiveness of US stocks for Europeans, and may eventually limit inflows into the US indices.

Secondly, on a brighter note, if you think that the euro is going to top out soon then this could make US stocks look attractive to European investors, and it may help to propel US markets to even greater highs.

Overall, as you can see in chart 2, which shows the euro and the S&P 500 normalised to show how the two move together, they have a fairly strong positive correlation. After diverging in the final quarter of 2016, the two have moved together since January. This is significant, as it shows that right now a strong euro (or a weak dollar) is not hindering the upward trajectory of the S&P 500, even though European investors’ are seeing their returns eroded by a stronger euro vs. the dollar. However, this chart is also a reminder that the two can also diverge, and at some point the FX impact, along with other factors, could be enough to break the cosy relationship between US indices and the stronger euro. This hasn’t happened yet, but don’t rule it out.

Chart 1:

The S&P 500 priced in euro 

Source: City Index and Bloomberg