US Dollar and Stock Market Correlation

11/27/2009 12:01 am EST

Focus: FOREX

Kathy Lien

Managing Director and Co-Founder BKForex LLC, BK Asset Management

Equities go up, the dollar goes down, and no one can agree on whether currencies are driving equities or vice versa. If you ask a currency trader, they will most likely say that the reason why the dollar sold off on any given day is because equities moved higher. However, if you ask an equity trader why stocks are up, chances are they will say that it is because the dollar is down. In reality, there is no easy answer, just like the question about what came first, the chicken or the egg.

Currency markets operate 24 hours a day, and to some degree, equities do as well on Globex. This means that even before the US equity markets officially open, traders are already expressing their views through futures. In general, the relationship between equities and currencies is much more symbiotic, which means that sometimes it is stocks that are driving currencies and vice versa. In the case of the chart below, an intraday chart of the EUR/USD and S&P 500 reveals that currencies have been leading equities and not the reverse.

Correlation Between Currencies and Equities

In the following five-minute chart of the EUR/USD and the S&P 500, we have circled two big intraday moves. In the first, the S&P 500 started to turn before the EUR/USD, but the move in stocks only gained traction after the big breakout in the EUR/USD. In the second area that is circled, the rally in the EUR/USD (blue line) peaked before the rally in stocks (green line). However, a closer look at the chart should also indicate that there are occasions where the S&P 500 makes a move before the EUR/USD.


Click to Enlarge

Taking a step back, the correlation between has been strong throughout the year. On a 12-month basis, the EUR/USD has had an 86% positive correlation with the S&P 500. Over the past six months, this correlation has increased to 94%. Yet the correlation has not always been this strong. For example, in 2007, the EUR/USD appreciated gradually throughout the year from 1.30 to 1.47. During that same time, there was a significant amount of volatility in the S&P 500 even though the index ended the year virtually unchanged. The correlation between the dollar and equities will break when the dollar finally moves on US fundamentals, meaning that good data becomes positive for the greenback. This will most likely occur when the US stages a full-blown recovery that eclipses that of its peers.

By Kathy Lien of GFTForex.com

EDITOR’S NOTE: In any case, it’s an interesting item to watch for any trader on an intraday basis.  For very short-term traders, watching both may present a trading opportunity when they don’t move together for a short time because they are bound to catch up to each other within a few minutes.

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