What's to Learn When the Dollar and S&P 500 Align and Deviate?
- US equities and the US dollar hold a number of fundamental similarities and differences that can be tracked to give key insight
- One of the prevailing role assignments between SPX and USD is as 'risk' asset and safe haven that sets a clear juxtaposition
- We have seen correlation between the two flip to a strong positive to negative relationship over the years as motivation has changed
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The Dollar and S&P 500 always move in distinctly opposite directions to each other because the former is a safe haven the latter is a 'risk' asset...right? A cursory glance at a chart will prove that that is certainly not the case. The two benchmarks relationship waxes and wanes while also flipping from positive to negative and back again. Clearly, dominant fundamental themes exert influence over these two key benchmarks, but that relationship is not always - it could be said not even 'often' - defined by their textbook alignment to investor sentiment. Looking back over just the past decade, we find a number of shifts where a medium-term (20-day) rolling correlation between the currency and index tightens to an extreme positive then switches to a longer-term (60-day) relationship that is broadly negative and then on to a seemingly independent path for both. There are strong ties between these two, but that does not always support a binary relationship nor does it mean they are always aligned. In fact, when we keep tabs on the relationship between the two, we can establish when important fundamental themes rise and fall in the market's focus - offering a picture of the broader financial system.
When we are at the extremes of the sentiment curve (panic to greed), there is certainly a strong polarizing influence on the benchmark US equity index and currency. For equities, we expect higher returns and in turn expect its risks to be commensurate to justify the chase. Alternatively, the fact that the Dollar is the most liquid currency in the world - and more importantly represents US Treasuries which are practical cash equivalents in finance - lends it an absolute haven title. In standard conditions, when there is a speculative run where yield-above-all-else is the motivation, we often find SPX advancing while the USD slides. Yet, that is not always the case. In fact, the sentiment landscape of in 2014 and 2015 saw a strong positive correlation between the two markets. That was certainly a period of risk appetite motivated by a certain degree of monetary policy and complacency. For the Dollar, the driver was the speculation that the Fed would be the first major central bank to pursue a normalization of its exceptionally accommodative policy. That is also why in August 2015, when equities suffered a severe bout of risk aversion that the Greenback was pulled down with it.
Circumstances can alter the currency's and equity index's place on the speculative curve. However, we also have instances were fundamental motivations change. Risk trends are not always driven aggressively higher or lower. The infusion of massive monetary policy by the Fed and others has certainly distorted the landscape a number of times. That same monetary policy bent led to the revival of the traditional negative correlation in 2009 when the adoption of the then-novel stimulus programs (TARP and TALF initially and QE programs later) were introduced undermining the currency and lifting capital markets. A more recent yet novel theme has arisen in 2017 with the swell of political forces. Immediately following the Presidential election, both Dollar and S&P 500 charged higher on the anticipation of growth-oriented programs from tax reform to regulation rollback to infrastructure spending. While that anticipation continued to fuel shares that were already looking for any and every reason to continue their climb, the enthusiasm for the Dollar turned to concern. A side effect of reduced revenue and significant increase in spending is an increased deficit which threatens another possible downgrade in the country's credit rating - another such move which could permanently alter the currency's standing on the international stage. What does the relationship between the Dollar and S&P 500 tell us about what the global markets are focusing on? We discuss that in today's Quick Take Video.
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