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Morning Briefing

Dow-Dollar re-examined

2nd July, 2000
Study reviewed on 6th Feb '01

We had last studied the relationship between the Down Jones Industrial Average and the $-Euro (inverse of Euro-$) rate on 28th December '99, and had detected a strong positive correlation between the two. This correlation suggested that the Dollar would weaken against the Euro due an expected fall in the DJIA Index.

Ironically, soon after we completed the study, the market proceeded to prove its findings to be incorrect. Over the period 30th Dec to 14th March, while the Dow fell from 11497.12 to 9811.24, the Dollar actually strengthened against the Euro as the Euro-$ rate fell from 1.0088 to 0.9680. In fact the Dollar continued to strengthen against the Euro right through to May when the Euro hit an all-time low of 0.8845.

DJIA-USD Inversion
We thought it would now be a good idea to re-examine this relationship. The graph alongside strongly suggests that the positive correlation seen uptil Dec '99 has been broken and that in the months ahead the Dollar can continue to gain against the Euro even as the DJIA Index falls. The thick Orange and Green "Trend Curves" are Polynomial curves generated by the statistical Method of Least Squares and have traced the overall direction and movement of the two series (Dow and Dollar) till now. Since these can be used to predict the future movement of the underlying series and these two curves are seen to be crossing each other now, we are forced to seriously consider the possibility that the Dollar can now continue to rise even as the DJIA falls.

What could, however, bring about such a change in the relationship, a change which seems to fly in the face of economic logic (how can a country's currency strengthen over a long period of time while its stock market falls?)

1) The best explaination that we can find is that a strong Dollar (against the Euro) continues to be in the best interests of the USA, which continues to be dependent on foreign investments to fund its massive trade deficit. The Dollar is the symbol of US supremacy and the USA will do everything within its means (and more) to safeguard it.
2) The Dollar is an international issue, while the DJIA is more of a domestic issue. The US can afford to let the Dow lose ground as long as the Dollar remains strong.
3) If the Dollar weakens along with a weakening of the Dow, the foreign investor will suffer on account of both a fall in the Dow as well as currency depreciation. Surely a strengthening Dollar has been a big incentive drawing investors to the USA. It is in the interest of the USA to see that this incentive remains intact.
4) Oil prices, now ruling near $30-31 per barrel are unlikely to go up much further from here and thus, going forward, they may not add significantly to inflation. On the other hand, if the Dollar weakens at this juncture, the trade gap will increase much more.
5) The Oscillators on the Daily and Weekly chart support a bearish Euro view.
6) If a currency is to be manipulated, the US can be expected to do a much better job than the hamhanded ECB.

So continues the battle of the Dollar versus the Euro, for it is a battle to own the rights to the universal symbol of Wealth - will Wealth be symbolised by the $ or by an "E".

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