Making Sense Of Dollar And Equity Strength

Over the past year, when U.S. equities rise, the dollar tends to fall because the improvement in risk appetite eases safe haven flows that have been parked in the U.S. dollar. When 3 month LIBOR rates in U.S. fell below Japanese levels, the correlation between equities and currencies exacerbated as the dollar became the funding vehicle of choice for investors looking to assume risk. This is what makes today’s price action in the currency market particularly mind boggling because the dollar actually strengthened on a day when stocks rose by the strongest amount in 5 weeks. The greenback appreciated against all of the major currencies except for the Canadian dollar and Australian dollars which saw buying pressure offset by a mild rebound in commodity prices. The Japanese Yen also held onto its recent gains even though it ended the U.S. trading session near its lows.

The rally in the dollar has been primarily attributed to the comments from ECB President Trichet who said that he supports a strong dollar policy. This was nothing new because he previously indicated that he believes the dollar should be strong as well, but with dollar short positions still at extreme levels, it apparently was enough to trigger a broad based rally in the greenback. We still believe that the ECB is not incredibly uncomfortable with the strength of the euro and therefore do not expect the dollar rally to last. U.S. stocks staged a very strong rally on Monday and bond yields fell which should have been dollar bearish. The Conference Board also reported that online help wanted ads fell by 101,800 in September, which suggests that Friday’s non-farm payrolls report may not be as healthy as everyone expects. We believe that the strength of the dollar today is more a reflection of the anxiety and nervousness amongst currency traders. It is also a few days before the month and quarter end when there is typically erratic volatility in the foreign exchange market. The weakness of the dollar in the third quarter most likely helped to boost foreign earnings for U.S. corporations and therefore some of the strength in the greenback could reflect repatriation of profits to window dress balance sheets. Therefore we don not expect the breakdown in the correlation between currencies and equities to last. Since the beginning of 2008, the correlation between the S&P 500 and the EUR/USD has been close to 90 percent.