Reader Questions Answered

The Relationship Between Stocks and Forex

I was asked a question by someone on my mailing list yesterday about the relationship between the forex and stock markets. Normally I include the text of the person’s question, but in this case English is not the person’s first language and the inquiry is fairly lengthy, so I’ll skip that in this particular instance. The bottom line is that like many folks this individual is wondering about why the dollar falls when stocks rally, and vice versa.

Following the Patterns and Relationships
As a professional forex market analyst I spend my days watching the all markets (not just forex) and seeing the various interactions between them. Some are subtle, fleeting, and likely only to be spotted by those looking specifically for them. Others are broad and obvious that anyone can see. The whole stocks up/dollar down pattern we’ve seen for some time now is definitely in the latter camp. Even the media is aware of it. 🙂

Back in June I did a presentation on cross-market analysis and trading at the L.A. Traders Expo. I was asked the question then what market tends to lead the rest. My answer was that it varies from day to day, and sometimes even hour to hour (for example the bond market has been tipping off dollar moves the last couple days), but in very general terms it tends to be the forex market which moves first, fixed income (interest rates) which follows second, and equities bringing up the rear (commodities probably falls in the fixed income area on the timeline, but they vary).

Risk Aversion and Carry Trade
The relationships between the markets varies considerably, though, so don’t make the assumption that what’s going on now will persist. Right now we have a situation where a couple of things are contributing to the inverse relationship between the dollar and stocks. One is the general risk aversion/flight to quality trade in which nervous market participants will tend to move money into the dollar for safety.  This isn’t as dominant a theme as it was a few months back, but is still a factor.

The other is the fact that the dollar has to a certain degree supplanted the yen as the carry trade short currency of choice (meaning the one that gets borrowed to be converted into a higher interest bearing currency). The carry trade is a highly risk sensitive position. Those trades will be closed when people are worried about the global economy partly on a safety basis and partly on the view that the higher rates could come down.

Seasonal Patterns in Action
Also keep in mind that so called “seasonal” patterns can influence things. This time of year has generally been a bearish one for stocks, but it has also been that way for the dollar (see Opportunities in Forex Calendar Trading Patterns). That creates an interesting conflict between the usual patterns. So far in September the dollar pattern, because of the inverse relationship, has cancelled out the usual bearish action we’d expect in stocks this month.