Are We Seeing the Dollar / Equity Markets Decoupling?

By Mike Conlon

U.S. dollar decoupling.

A lot has been made about the “flight to safety” and risk aversion trade in the currency markets. That is, whenever there is some sort of negative economic news or global crisis, money comes pouring back into the U.S. dollar. So when things are going well and equity markets, both here and abroad are going up, the U.S. dollar is expected to go down.

This always struck me a sort of funny; after all it was the all the economic bad behavior here in the US which has caused the global crisis. But nevertheless, that’s just the way it’s been. The correlations have been in place and investor psychology is such that if traders believe that the U.S. dollar is the safest place to be when the stuff hits the fan, who am I to argue?

That’s why Friday’s market action after the Non-Farm Payrolls report struck me as rather odd. Both the equity markets AND the U.S. dollar gained as the S&P 500 index ETF (SPY) and the Powershares U.S. Dollar Index Bullish (UUP) were up 1.3% on the day.

So what’s going on here? Let’s have a look.

Market correlations are important and they usually work great…. until they don’t. There are a few possible reasons why Friday’s NFP report sent both the U.S. dollar and the equity markets moving in the same direction.

Click to enlarge:

The first reason is that the dollar may be acting more on the fundamentals rather than the correlations. The Friday NFP report was seemingly “good news” as the equity markets responded positively so this could mean a decoupling for the dollar from the flight to safety trade.

Treasuries responded sharply to the news with 10-year yields surging 10 basis points to 3.854%. This could signal a turn-around in the dollar, as the data is showing that the economic contraction is slowing.

Also, this Wednesday, the FOMC meeting on interest rates will take place and the Fed is expected to leave rates unchanged. However, it may signal that its policy of buying Treasuries may be coming to an end if that data points to economic recovery, which would bode well for U.S. dollar strength.

Should this occur and the dollar retains its “safe haven” status, then this could loom large for equity and oil markets. Because oil is denominated in U.S. dollars, it tends to trade inversely to the dollar. Or we may just see the dollar/stock market correlation break down.

Either way, be prepared for some potential volatility and remember to trade what you see and not what you think you know. I’ve seen more than one trader lose big when a correlation he thought was iron-clad de-coupled. And last Friday’s action may be a sign that this about to be the case.

Disclosure: The author may have a position in some of the securities or currencies mentioned in this article

Original article

Comments

[Asbytec:]

I suspect you and others telling of this trend might be right. Anyway, it's about time the dollar was backed by something other than fear. Still, despite the rally and green shoots, we're still not out of the woods, in my view. So, we might see a flight to safety strengthen, again. I hope not.

Aug 11 08:54 AM