Quants Find Secret to Divining Dollar's Path in VIX, Iron Ore

  • Interest rates losing their power to explain greenback moves
  • Goldman warns equity volatility may hit emerging-market FX

For the better part of 2017, trading the dollar has meant trading the bond market. 

Not anymore.

In fact, now you’re just as likely to be able to divine the dollar’s direction against the yen by tracking measures of stock volatility and the price of iron ore as you are by monitoring the U.S.-Japan yield spread, according to Quant Insight, a research firm that develops models to identify the macroeconomic drivers of various assets.

At a time when investors are agonizing over whether an almost three-year rally in the dollar has further room to run, understanding the evolving dynamic between currencies and other assets has become increasingly critical. The growing clout of metals and equity-market price swings shows foreign-exchange traders are shifting their focus from monetary policy to the prospects of fiscal stimulus and geopolitical risk, said Mahmood Noorani, a former portfolio manager at BlueCrest Capital Management who founded Quant Insight in 2014.

"We noticed dollar-yen’s moving around, but it’s not moving with rate-differentials anymore," said Noorani. "We were scratching our heads, then we started to realize metal is acting as a proxy of Trump infrastructure spending. Rate differential is still there. But it’s become weaker."

Earlier this year, a one standard deviation move in the U.S.-Japan yield curve spread would produce a 2 percent shift in the dollar. Now, it’s around 0.5 percent. Meanwhile, a similar move in volatility gauges of U.S. and emerging-market stocks now explains a 0.34 percent shift in the U.S. currency, Quant Insight found. Three months ago, it had almost no impact. Iron ore paints a similar picture.

There are a number of reasons to heed the signals from Noorani and his team: their model, which analyzes around 30 macroeconomic factors from rate differentials to China’s credit default swaps, explains 91 percent of the movement in dollar-yen over a rolling four-month period. It sent out warning signals in mid-February before the dollar peaked. The framework was developed by Michael Hobson, a professor of astrophysics at the University of Cambridge.

Quant Insight isn’t the only firm monitoring the influence of the VIX. Emerging-market currencies have been unusually sanguine about the decline in U.S. stocks, as improving economic outlooks in developing nations encourage investors to pile into the region’s assets, according to Goldman Sachs Group Inc. The risk is investors will be caught on the wrong side if the S&P 500 selloff accelerates, like it did around mid-2016.

— With assistance by Cameron Crise

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