Have you been paying attention to the changing markets?
Once upon a time all the talk was about how stocks and the dollar traded in opposing directions. The chart below with weekly bars shows how that was definitely the case until the latter part of 2011 (S&P 500 left scale, blue plot; USD Index right scale, black plot). Since then, though, with the exception of a few months earlier this year, the two markets have been trending higher roughly in tandem.
That’s a bit of an illusion, though.
You see, the USD Index is very heavily weighted toward the euro. That means it trades very close to how EUR/USD trades. As a result, it doesn’t always provide a comprehensive view the way we’d normally expect from an index.
Here’s something a bit more representative. It’s the same weekly chart, but swaps out the USD Index and replaces it with AUD/USD. Here you can see a VERY close correlation between the two markets.
So why the difference?
Well, AUD/USD is a good proxy for the so-called commodity currencies. Other commodity-oriented pairs are NZD/USD, USD/CAD, and many of the emerging market pairs like USD/MXN and USD/BRL. These are economically sensitive currencies, so they have a strong link to the stock market. Thus the strong correlation.
The euro, on the other hand, has all sorts of stuff going on which influences its exchange rate. It’s not just a function of economic growth but also of monetary policy and general confidence. The same can be said about both the yen and the pound. Further, since the Swiss National Bank effectively has the franc pegged to the euro (it’s really a floor on EUR/CHF, but is acting like a peg), the CHF is basically trading the same as the EUR.
What this all means is that we can no longer just look at “the dollar” and its relationship to stocks, commodities, and interest rates. We have to account for the variance in the performance of different currencies depending on the influencing factors if our analysis can have any validity. We may get back to the point where EUR/USD and the S&P 500 close correlate as they have done in the past, but for now we need to focus on the likes of AUD/USD and USD/CAD in our inter-market analysis of stocks, commodities, and the greenback.
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