So far, the month of February has seen the stock market rally impressively, while the value of the U.S. dollar has slipped. Are currency traders and stock market investors reading different newspapers? As inconsistent as the actions of U.S. stocks and the dollar might seem, they have a root cause in common: weakness in the U.S. economy.
A currency trader's perspective
Some speculate that the accumulating evidence of weakness in the U.S. economy will force the Federal Reserve to prolong its easy monetary policies. From a currency trader's perspective, aggressive monetary stimulus does two things: It lowers interest rates, and it erodes the creditworthiness of the government. Both of these reduce the attractiveness of the dollar. The dollar's slide might be more pronounced, except that other economies are so dependent on the U.S. as a trading partner that what is bad for the U.S. generally touches other nations as well.
The stock market's perspective
While the dollar has stumbled, the U.S. stock market has regained just about all the ground it lost in January. Why is Wall Street so happy? Because those same low interest rates that undermine the dollar help to boost the relative attractiveness of stocks. In fact, in many cases the weak dollar is a bonus to U.S. companies, because it improves their pricing position relative to foreign competitors. Perhaps the biggest short-term win for the stock market may come with the Federal Open Market Committee's next meeting in mid-March. That's when the Fed will announce whether it will continue to taper back its quantitative easing program. If the weakening economy forces the Fed to slow down the tapering schedule, it will signal that low interest rates are here for a while longer. Ultimately though, stock investors may regret getting too exuberant over low interest rates that are a result of a weak economy. Low interest rates may improve the relative value of company earnings, but ultimately those earnings have to grow for a stock to make sustainable progress. In a weak economy, earnings growth will be hard to come by.
It's unanimous: Savings accounts lose
While the dollar is going down and the stock market is going up, both reflect the same thing -- more downward pressure on interest rates.