Dollar Advances for Third Straight Day, Momentum and Fear Easing

Volatility eased for a second day Thursday and underlying risk trends (measured through the S&P 500) carved out a fourth day of consolidation. Normally, we would expect the dollar, as the premier liquidity haven, to respond to this shift with a meaningful downturn of its own. Yet, that has been the case. In contrast to the technical (close over close) four-day advance from the benchmark US equities index, the Dow Jones FXCM Dollar Index has advance for three consecutive sessions. Furthermore, each of these drives higher has set a fresh 15-month record for the currency. What are we to make of this? The 20-day rolling correlation between the S&P 500 and Dollar Index is still an exceptional -0.93 (-1.00 indicates that they generally move in exactly the opposite direction); but the shorter, five-day (one-week) reading relationship reading has actually flipped to a significant positive figure.

It would be hasty to label this relationship change as a critical shift in the dollar’s association to underlying fundamental trends. That said, a breakdown in correlations often occurs after a thematic driver eases off on the pressure. Naturally, when we do have make turns (whether they are temporary corrections or true reversals), we see the intensity behind a fundamental drive ease and market participants ease off the gas in anticipation of the next catalyst – more sensitive to both favorable and unfavorable developments. The divergence in correlation is working on the dollar’s favor – as are the momentum behind the euro unwind, the deteriorating rate outlook for its investment currency counterparts and the greater sensitivity of the high-yield currencies. However, these factors are unlikely to continue working in harmony to supplement the dollar’s primary safe haven role. If equities gain traction in a rebound or should the second factors fade against a slow risk build, the dollar will falter.