The U.S. Dollar Is Ever So Slowly Losing Its Risk Appeal

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Includes: FXE, FXF, FXY, SPY, UUP
by: Duru

The S&P 500 (NYSEARCA:SPY) lost 1.6% on Tuesday (August 27th) as follow-through selling from the previous day overtook the index. Rising tensions between the U.S. and Syria are providing the catalyst for the breakdown in the S&P 500. The U.S. dollar has typically served as a refuge and a "safety currency" during times of geo-political tensions and crisis. Not quite this time it seems. I was quite surprised to see the dollar index (NYSEARCA:UUP) close down on the day. It was marginal but still notable.

The dollar index remains stuck in a trading range

The intraday reversal can be seen in the way the euro (NYSEARCA:FXE) responded after the opening of trading in U.S. stocks. The euro is about 58% of the U.S. dollar index.

15-minute chart shows the abrupt volatility in forex trading

Source: FreeStockCharts.com

Within minutes, the trade ended as quickly as it began, but it still caught my attention.

Since 2010, the S&P 500 has closed -1% or worse on 120 trading days. On 94 of those days, or 78%, the U.S. dollar index has closed with a gain. On 65% of these 120 days, the Japanese yen (NYSE:FXY) closed higher against the U.S. dollar. On only 36% of these 120 days, the Swiss franc (NYSE:FXF) closed higher against the U.S. dollar. Finally, on only 15% of these 120 days, the euro closed higher against the U.S. dollar. All these stats include today, a day where the dollar index closed down and all three currency ETFs - FXY, FXF, and FXE - closed up (1.42%, 0.14%, and 0.49% respectively). I used the currency ETFs to match up with the U.S. trading day.

The change in relationship is noticeable in 2013. This year, the S&P 500 has closed -1% or worse on 14 trading days. On only 8 of those days, or 57%, the U.S. dollar index closed with a gain. On 79% of these days, the Japanese yen closed higher against the U.S. dollar. On 50% of these days, the Swiss franc closed higher against the U.S. dollar. Finally, on 36% of these days, the euro closed higher against the U.S. dollar. In other words, the yen, not the dollar, has been the clear go-to currency on down days in the stock market and both the euro and the franc have enjoyed notable jumps in popularity.

For reference, the typical odds for a positive close for these currencies is close to 50/50 on any given day since 2010. Of 910 trading days since 2010, the U.S. dollar index has closed up 453 times, or 50%. For FXY, FXF, and FXE these percentages are 53%, 53%, and 51% respectively.

Since the S&P 500 has rarely sold off in magnitude this year, the idea of the dollar losing its "risk appeal" has yet to be fully tested. However, I think the signs are there, especially with interest rates generally trending upward right now. This possibility is important from a trading standpoint since I am still biased long the U.S. dollar, short the Japanese yen, and short the euro. If the stock market goes into some kind of sustained sell-off, I may have to drop all three biases. I think the notion of safety in currencies is an odd one during these times where major central banks want weaker currencies; still, the rush to safety must be respected as a potentially powerful trading force.

This changing behavior in currencies on large down days in stocks is also of interest because it demonstrates that, much to my surprise, the euro continues to gain favor ever so slowly. I do not think this grace period will last, but I have to temper my bearishness after seeing the euro's resilience in times of excess volatility. FXE has not yet made a new high for 2013 (set on February 1), but if it does, I will take that as confirmation that the euro has finally turned the corner… and I will have to give all things euro a second look.

Be careful out there!

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: In forex, I am net long the U.S. dollar, net short the Japanese yen, euro, and franc.