Dow Jones And Euro Break Higher
Improved US macroeconomic data, another quarter of solid earnings and de facto quantitative easing by the European Central Bank (ECB) have propelled the Dow Jones Industrial Average to its highest close since 2008 – with the index breaking above the highs of mid-2010 yesterday. Although some caution is warranted given the somewhat overstretched recovery staged by US equities since early October 2011, the move to a new high, the recent uptick in US hiring and global manufacturing (ie global growth), the prospect of monetary easing across the globe, and far-from rich valuations all suggest that upside remains for global equities.
US Dow Jones Industrial Average
Concurrently, the euro has broken above resistance. Back on January 19, we anticipated a rally in the euro to US$1.3250/EUR, stating that “the euro’s move higher [through resistance]… has been accompanied with the Dow Jones breaking through resistance at 12,500… in the short-term at least, the euro and equities may be set to recouple and move higher in lockstep… contrary to a view we have held since October, for divergence between equities and the euro”.
Exchange Rate, US$/EUR
We note that there has been such a recoupling between the euro and US equities, no doubt helped by an unwinding of stretched bearish sentiment on the single currency. Since January 19, the 30-day rolling correlation between the S&P 500 and the US$/EUR exchange rate has risen from –49% to +54%. It appears likely, given the technical moves highlighted above, that a concurrent move higher in both the euro and US equities remains on the cards in the short term – the next level of resistance for the euro comes in at US$1.3650/EUR.
Nevertheless, we remain far from optimistic on the euro’s medium-term trajectory and view short-term strength merely as the preamble to a bearish move. Indeed, we anticipate the ECB’s second Long-Term Financing Operation on February 29, which will dramatically increase the size of the monetary authority’s balance sheet yet again, to see the euro take another leg lower against the US dollar. This should, however, come to the benefit of global equities – resulting in a resumption of the medium-term divergence between the euro and US equities in place since October.