Graphic content – January; the US dollar is now a ‘risk on’ currency
11th January 2017
The perception of the US dollar is that it’s a safe haven currency; when things go wrong in the world, you want to own it. This perception has been broadly accurate since 2004, where the US dollar has tended to be negatively correlated to risky assets.
Since 2014, however, the correlation has weakened, and the US dollar has at times more closely resembled a risky currency than a safe haven. Capital has increasingly been attracted to US markets by stronger relative growth and higher relative interest rates, which has served to push up both US equity prices and the US dollar.
Donald Trump’s election has sparked a new euphoric phase, where the reflation narrative has supported global risk assets, and the higher relative US interest rates that would result from a stronger US economy have once again attracted capital flows into the US.
The chart below plots the correlation of the US dollar versus both the MSCI World equity index and global high yield credit spreads. We have taken the US real effective exchange rate (i.e. trade weighted, adjusted for inflation) as a US dollar proxy, where the rolling 3-month correlation to MSCI World is on the right axis, and the rolling correlation to global high yield credit spreads is inverted on the left axis. The correlation with equity is notably stronger than that of credit spreads. Nevertheless, rarely has the US dollar’s positive correlation to risky assets been stronger than now.
Click graph to enlarge
It is, therefore, plausible that the US dollar stands to suffer when we get the next market wobble, not least because speculative positioning in both the US dollar and a number of linked asset classes has now reached extreme levels (more on this in our next blog). The euro is likely to perform strongly in a risk off move as global rates converge back to euro rates, unless the source of the risk off event is the Eurozone itself (quite possible). Monetary policy convergence would also propel the Japanese yen considerably higher, although that is less unusual.
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