Dollar Correlates to Stocks in Economy Obama Desires: Currencies

The dollar is moving more in tandem with stocks than any time since 2008 in a sign that traders are gaining confidence in the sustainability of the U.S. recovery.

The U.S. Dollar Index and the Standard & Poor’s 500 Index are the most closely correlated since the start of the global financial crisis, according to data compiled by Bloomberg. The gauges started moving more in lockstep last month as the greenback jumped to an almost three-year high and U.S. equities surged to a record.

Traders retreating from emerging markets are seeking America’s currency as everything from jobs to consumer confidence and housing fuel the economy while the euro zone struggles with recession, Japan debases its currency and the U.K. stagnates. Rising U.S. bond yields as the Federal Reserve debates whether to slow bond purchases are adding to the dollar’s allure.

“The whole correlation structure in the market is shifting,” Jens Nordvig, global head of foreign-exchange strategy at Nomura Securities International Inc., said by phone from New York. “The way the dollar is trading relative to risk is totally different. The way the dollar is responding to news is totally different. ”

Correlation Coefficient

The 30-day correlation coefficient between the Dollar Index and the S&P 500 reached 0.28 on May 30, the highest level since October 2008, before falling back to 0.1 yesterday, data compiled by Bloomberg show. That compares with as low as minus 0.9 on Nov. 15, 2011. A reading of 1 means the gauges move in lockstep, and minus 1 means they move in opposite directions.

IntercontinentalExchange Inc.’s Dollar Index, which tracks the greenback against the euro, yen, pound, Swiss franc, Canada dollar and Swedish krona, dropped 0.2 percent to 80.815 as of 12:31 p.m. in New York. It’s gained 1.3 percent this year and reached 84.498 on May 23, the highest level since July 2010. A day earlier, the S&P 500 rose to a record 1,687.18, and it has risen 14 percent this year.

The positive correlation implies traders expect growth in the world’s largest economy to boost stocks and also push the dollar higher. U.S. gross domestic product will expand 1.9 percent this year and 2.7 percent in 2014, beating the Group of 10 average of 1.09 percent and 1.95 percent, according to the median estimate of economists in separate Bloomberg surveys.

Shrinking Deficit

President Barack Obama’s administration is benefiting from an economic revival as he seeks to shrink the budget deficit. The bipartisan Congressional Budget Office said May 14 that the shortfall will be reduced this fiscal year to $642 billion, the smallest since 2008 and less than half 2009’s record $1.4 trillion deficit.

“Our deficits are going down faster than they have gone down in decades,” Obama said May 17 in Baltimore as he touted efforts to push infrastructure projects. “The American auto industry is thriving. American energy is booming.”

A stronger economy is also bolstering speculation the Fed will reduce the $85 billion of Treasuries and mortgage securities it buys each month. The central bank prints dollars to make the purchases and inject cash into the financial system, debasing the currency in a policy called quantitative easing.

Economists estimate the Fed will reduce the pace of purchases to $65 billion a month at its Oct. 29-30 meeting, according to the median estimate in a Bloomberg News survey.

Carry Trade

With the central bank adopting near-zero interest rates since December 2008, some investors turned to the dollar to fund purchases of higher-yielding assets, weighing on the currency.

Selling the U.S. currency versus a basket of the Australian dollar, Brazilian real, Canadian dollar, Mexican peso and New Zealand dollar would have generated a 26 percent return in 2009, according to calculations using Bloomberg Carry-Trade Data. The same trade would have lost an annualized 4.3 percent if initiated at the start of 2013.

“The whole nature of the dollar as a funding currency is breaking down,” Nomura’s Nordvig said.

The potential for tapering of Fed bond purchases has led to higher yields on Treasuries. Yields on Treasuries due in 10 years were as much as 0.62 percentage point higher than the average for sovereign markets elsewhere with similar maturities, the most since mid-2011, Bank of America Merrill Lynch indexes show. As recently as November there was no difference.

Capital Flows

While the correlation between the dollar and riskier assets such as equities is “the big trend this year,” stronger capital inflows may be necessary for the trend to become entrenched, according to Vassili Serebriakov, a foreign-exchange strategist at BNP Paribas SA in New York.

“We’re not really seeing signs of that yet,” he said in a telephone interview on June 10.

International demand for U.S. stocks, bonds and other financial assets weakened for a second month in March. Net sales of long-term equities, notes and bonds totaled $13.5 billion, the most since May 2009, following net sales of $13.3 billion in February, the Treasury said May 15.

The Bloomberg-JPMorgan Asia Dollar Index, which tracks 10 currencies against the greenback, fell to a nine-month low this week as the Malaysian ringgit, the Korean won and the Philippine peso led the decline. A similar index of Latin America currencies dropped to its lowest in a year.

Trend Reversal

“Quantitative easing means a lot of creation of liquidity, and then there was a search for yield,” Bernd Berg, a global emerging-market foreign-exchange strategist at Credit Suisse Group AG, said by phone from Zurich. “This trend we saw over the past couple of years is somewhat reversing itself because you have Treasury yields in the U.S. rising and at the same time you had yields in countries like Australia coming down.”

The dollar’s inflation-adjusted value against its major trading partners is 10 percent below its average since 1994. A gauge of the currency’s real-effective exchange rate was 97.64 in April, compared with the record 93 reached July 2011, the latest data from the Bank for International Settlements show.

Investors are looking for clarity on whether the Fed will pare stimulus before the dollar can become a currency that has a clearer positive correlation with growth, according to Peter Frank, global head of currency strategy at Banco Bilbao Vizcaya Argentaria SA in London.

“That will be the final piece in the jigsaw to be put in place to turn the dollar into a fully pro-cyclical currency,” Frank said in a June 11 telephone interview. “You will see a much higher correlation between risk metrics such as equity prices and the value of the dollar. There’ll be a much stronger positive correlation.”

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