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Why Does the US Dollar Want Stocks to Go Higher?

Why Does the US Dollar Want Stocks to Go Higher?

Talking Points:

- Main source of risk aversion past month has been geopolitical in nature; with geopolitical tensions subsiding momentarily, investors have been leaving safe haven assets and returning to riskier positions.

- US equity market rebound going hand-in-hand with US Treasury yields rising; inference is that US yields dropped on safe haven demand. Further improvement in risk appetite should boost US yields further, lifting the US Dollar.

- Retail crowd positioning has eased, but remains near extreme levels in a few USD-pairs.

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The economic calendar is quiet once again for the US Dollar, with the often overlooked Producer Price Index marking the only notable data release for Wednesday. The early-week release lull will end tomorrow, however, with the August US Consumer Price Index and the August US Advance Retail Sales report on Friday.

Until these two key data series are released - culminating in an update to the Atlanta Fed's GDPNow tracker on Friday - the US Dollar is left to the whims of the general newsflow and market sentiment. Fortunately for the US Dollar, these factors seem to be turning in its favor.

The drop in the US Dollar in late-August coincided with a plunge in US Treasury yields - not much of a surprise there. But the drop in US yields coincided with US equity markets falling back, a sign that price developments were tied to the same source: the newswire churning out stories about rising geopolitical tensions between North Korea and the United States.

Now that geopolitical tensions appear to be subsiding in the near-term, the shift to safer assets has stopped. Investors are no longer dumping US equities for the relative safety of US Treasuries, and in turn, US yields have been given room to rebound quickly alongside stocks. Accordingly, further gains by US equities should pull up US yields further, which will only serve to the US Dollar's benefit, particularly against the lower yielding safe haven currencies, the Japanese Yen and the Swiss Franc.

It's important to respect the technicals of the market, which thus far suggest the US Dollar hasn't bottomed yet. Mainly, the DXY Index hasn't closed above its daily 21-EMA since June 22 (during which time EUR/USD hasn't closed below its daily 21-EMA since June 22 either (no surprise there, considering the Euro is 57.6% of DXY). Confirmation remains to be seen for a DXY Index low until the August 25 bearish outside engulfing bar is cleared out at 93.44.

See the above video for technical considerations in the DXY Index, EUR/USD, GBP/USD, USD/JPY, USD/CHF, and Gold.

Read more: Bump in Risk Appetite Helping US Dollar Regain Footing

--- Written by Christopher Vecchio, CFA, Senior Currency Strategist

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DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.