Why Stocks and the USD Are Now Moving Together

Historically, the USD and stocks have moved together. However, over the past two years, the dollar has in fact moved opposite stocks. Why?

The Good News Wasn’t Good For the USD

The very low USD interest rates meant that traders had no reason to want dollars when there was optimism/risk appetite, because there were much better yielding alternative currencies like the AUD or even EUR that would also benefit from growth. This buying of high yield currencies and selling low yield ones to fund these purchases is called carry trade.

Moreover the "good news" we’ve seen for the US economy over the past years DID NOT help unemployment and consumer spending, the very issues that were forcing the fed to keep stimulus flowing, rates low, and thus the USD a sell relative to other currencies. The "good news" was of the "less bad than expected" unemployment, spending, or corporate earnings data. Good for stocks, but not for the USD. Thus stocks would rise, investors would buy other FX and sell the USD to fund these purchases

What Has Changed?

As we’ve noted repeatedly, at least 1 of 3 things had to happen to stop the USD slide:

* A panic event, which bids up demand for low yield currencies like the USD as carry trades unwind with rising fear.
* Improvement in US economic fundamentals that improves expectations for interest rate increases (i.e. in employment and consumer spending)
* A decline in EUR fundamentals that weakens the EUR and thus causes the USD to rise, because these currencies move in opposite directions due to the EUR/USD comprising nearly a third of all FX trade by itself. That means for every 3 EUR bought a USD is sold and vice versa.

Recently, we’ve had all three. Most importantly, the ‘good news’ for the US economy was improving employment and spending conditions. Not only has the unemployment rate and rate of new job losses almost stopped, there is a surge in temporary hiring, which is believed to indicate employers are moving closer to hiring full time staff. Consumer spending has also risen.

This news suggests not only higher earnings, which are good for stocks, but also sooner than previously expected stimulus reduction and interest rate increases for the US. Rising US treasury yields have also fed this expectation, as rising stocks draw capital away from US government bonds, which forces their price down and thus their yield up.

Will this traditional relationship continue?

Whether this traditional relationship continues will depend on whether the US continues to see overall improvement in jobs and spending data, which is good for both stocks and the USD. (source: http://seekingalpha.com/article/179551-why-stocks-and-the-usd-are-now-moving-together)