New Age for Dollar/Equity Correlation

11/09/2011 9:56 am EST

Focus: FOREX

Boris Schlossberg

Managing Director of FX Strategy & Co-Founder of BKForex LLC, BK Asset Management

Even equity traders must watch the US dollar these days, says Boris Schlossberg, who assesses how dollar news and other fundamental factors are impacting markets the world over.

All eyes seem to be on the US dollar recently. In more recent years, traders have been trading it outright or at least watching it even if they’re equity traders. 

Our guest today is Boris Schlossberg to talk about what he feels is going to happen with the dollar coming forward. So Boris, talk about your thoughts on the dollar going forward here.

It’s really amazing how the dollar and the equity markets have become completely correlated over the last several years, or interrelated at the very least. 

You know, when we watch news networks or the business networks, all the time they’re talking about the dollar as much as they’re talking about equities. I think exemplifies the fact that we’re now completely interconnected on all the global markets. It’s very important to watch them both. 

So the dollar has had a little bit of strength recently for two reasons. One, the market has been so convinced that the Fed is going to go out there and try to do a third round of quantitative easing (QE) and flood the market with more dollars and essentially dilute the currency further. 

The fact that it did not at the latest FOMC meeting has really created a lack of expectations and an unwind of those expectations. So the dollar has gotten a benefit out of that, partially. 

Also, the market was looking for leadership on the fiscal side to try to stimulate the US economy. We haven’t had that because we’ve had so much rancor in the US political spectrum. 

Recently, we’ve seen President Obama put forth a jobs bill that could possibly be stimulative, and the market now feels that it’s the fiscal officials that may finally take the baton and actually begin to try to stimulate the economy, versus the monetary officials.

That has been why the dollar has been so weak because the way monetary officials stimulate the economy is by printing more dollars, and that becomes very negative for the currency. 

If fiscal officials can actually create some demand, which is really the underlying driver of need in the US economy, then that could actually be positive in 2012.

We could see hopefully a reduction in unemployment and then in turn we’d be dollar positive on just a purely fundamental basis.

Are you surprised to see the dollar strength knowing that we have printed so much money in QE1 and QE2? We haven’t seen inflation, we haven’t seen that really affect the dollar and it’s still stronger here.

I’m actually not surprised that we haven’t seen inflation because I think the Fed’s argument has been extremely valid. 

We’re at a time right now where the biggest single problem for businesses is demand. There is lack of demand.  It’s very much a Japanese problem. 

Remember the Japanese printed tons and tons of yen and continue to do so all the time, and yet they’re facing deflation. That has to do with what’s called the "multiplier of money." 

It doesn’t matter how much money you print, if people don’t spend it, if they don’t circulate the money within the economy, there’s very little demand, and therefore, you actually are facing deflationary prices. 

So that’s what we’ve seen recently in the US economy. However, and you make an interesting point, over the last few data points, we’ve actually seen an uptick in US prices, which suggests that we may no longer be in a deflationary environment.

That’s perhaps yet another reason why the Fed decided that they didn’t want to have to go to QE3 because they really didn’t want to exacerbate a situation and perhaps turn the problem into an inflationary problem. That would be very, very dangerous. 

So yes, for those reasons the dollar is starting to strengthen now.

All right, any specific levels you’re watching very carefully on either the downside or the upside to see where it may go?

Yeah, if you’re looking at EUR/USD, and you know, the dollar is really sort of a very different story. The USD/JPY of course has just been on a one-way decline and the yen has been strengthening, but EUR/USD has seen some strength against the euro. 

It broke the 1.35 level recently, and I think it’s reasonable that by the end of the year, we may be seeing 1.30 on EUR/USD as we go forward.

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