Over the past year one of the biggest themes has been to short the US Dollar and go long anything that is considered risky. If you bought stocks, any grade of corporate bond, commodities, even real estate stocks and you would have made money. Many strategists, The Macro Trader included, used the falling US Dollar as a reason to go long stocks, bonds, commodities, etc. The reason of course is that since the March bottom the USD and the SP500 have been almost perfectly inversely correlated. Well that relationship appears to be breaking down right now as the US Dollar has been rallying and other risk assets have not been falling in sympathy.
In the chart below you can see how as the US Dollar has fallen, the SP500 has risen. In fact when there is a wiggle in the USD there is an opposite move in the SP500. As you can see in the bottom right hand corner the USD is rallying while in the top right hand corner the SP500 is still looking strong. (Click on chart twice to enlarge)
US Dollar vs SP500
Of course if this inverse correlation is falling apart the correlation between the SP500 and the Euro is also falling. Apparently, at least for now, you are able to be short the EUR/USD and still be long stocks and make money. Looking at the chart below you can see almost the exact opposite of what we see with the US Dollar. As the SP500 has moved higher the Euro has climbed as well until the last few weeks as the Euro has tumbled and equity markets as well as other risk assets have managed to remain strong and in many cases hit new highs. (Click on chart twice to enlarge)
Euro vs SP500
What do we take from this? One thing is that the carry trade using the US Dollar was not as heavy as many people feared. Another thing is that the market is always changing and that many intermarket relationships work well in some periods and fall apart in others. As always it is important that we have solid risk management principles and that we are open to change. For now we are short the EUR/USD and long equities…but that could change tomorrow.
Disclaimer-The Macro Trader is long several equity index ETFs such as IWF, EWZ, and MOO and we are short the FXE-Euro ETF.
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Title: US Dollar Correlations Breaking Down