The Beginning of a Beautiful Friendship? Well, Maybe

For the better part of 2009, the US dollar and the S&P 500 were on pretty bad terms - as one went in one direction, the other took off in the complete opposite direction. In other words, a strong inverse correlation dominated the relationship between the two. In April 2009, George Soros succinctly described the dollar as the "fever chart" of the economy. Indeed, as the US economy recovered from near-death experience, the fever chart (i.e. dollar strength) went steadily down. Recently, though, the US dollar has been seen walking hand in hand with the S&P, signaling a break from the inverse correlation and a possible, new, positive correlation.

Market correlations form, and fall apart, as dictated by shifting market dynamics. For example, most of the time the correlation between the USD and the price of commodities is inverse. However, in some situations one can observe a positive correlation between the them. Such was the case earlier this year when the dollar and gold rallied at the same time. It is important to take note when a well established correlation breaks or reverses, as it may signal changing market dynamics.

The dollar and the S&P are like a celebrity couple and their relationship garners lots of interest and speculations. But like a celebrity couple, they like to keep everyone guessing - will they stay together, or not? When trying to answer this question, we must first note the fact that we are in year-end/holiday trading mode which means thin volume across the board and a general reluctance on the side of big money managers to take on sizable positions. Having said that, we must also note that it is perfectly normal for currencies and equities of the same country to march in tandem - commonly a sign of a strong economy heading toward, or in the process of, interest rate hikes.

It may be a stretch to describe the US economy as "strong" but I think most people agree that things are getting better and interest rates can only go up from their current levels. It is quite possible then for forward-looking markets to anticipate another step toward normalization which may explain the dollar's and equities' newly found friendship. Will the new relationship hold? Only time will tell.