Stocks and the Dollar Both Up at the Same Time?

Have you been paying attention to the changing dynamics in the markets of late?

We’re no longer in a world where the dollar moves in the opposite direction from stocks on a consistent basis – the risk-on/risk-off pattern. Of late, in fact, stocks and the buck have moved in the same direction, as we can see in the chart below (USD Index in green, S&P 500 in black). For the last few weeks that direction has been higher.

S&P 500 Chart

As we can see from the weekly chart below, things have been pretty muddled all year long. The stock/dollar correlation (based on a 20-period calculation) has been a bit positive since December, though only slightly so. Basically, the two markets have been mainly uncorrelated, taking us back to a time when the financial markets mainly traded on their own factors.

Ahhhh…the gold old days. :-)

Weekly S&P 500 Chart

Right now the thing that has the two markets moving in unison is something that was actually part of the story even back during the financial crisis. The US markets are benefiting from the view that the US is well into recovery mode while the Europeans (the USD Index being heavily weighted in those currencies) still have a lot of stuff to work through to get themselves on track.

Now, the European problem has been in place for a while now, which is why if we look at the relative performance of the S&P 500 and the German DAX index below we can see that while US stocks have pushed above last year’s highs, German one still have a ways to go.

S&P 500 Chart

What’s changed of late where the dollar is concerned is the view on what the Fed will be doing – or more correctly, what it won’t be doing. The better US data has lessened the need for Bernanke & Co. to further loosen monetary policy by piling on new quantitative easing (QE) at some point, and statements out of the central bank have indicated that these figures aren’t being viewed as some kind of anomaly, but rather as part of a developing pattern. This reduces even further the odds of QE3, and as the chances of the Fed pumping more dollars into the system decline, the dollar is at least less pressured, if not outright supported from buying by those who expected QE3, especially in the face of the ECB dumping close to a trillion euros into the system via the LTROs.

So we’ve got improving economic data helping stocks and also helping reduce the chances of Fed action which would be negative for the dollar. That’s what’s causing the two markets to move in tandem of late. Just keep in mind, however, that the dollar tends not to do great when (all things being equal) when the US economy is very strong because of our increasing demand for imports. We’re not exactly in strong economy mode yet, but it’s something that will become a factor as things improve.

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