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Is the Dollar, S&P500 negative correlation dying out?
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Is the Dollar, S&P500 negative correlation dying out?The U.S market has gone through its ups and downs over the past year, dropping tremendously due to a severe subprime and financial crisis, only to present a strong rebound within a short couple of months. Even though economic data has shown mild improvement, Friday’s event told a different story, showing that the U.S economy could now be at a critical turning point.
After 4 days of suspense, the Bureau of Labor Statistics released its awaited job numbers, surprising analysts with better than expected results. According to the numbers, the U.S economy shredded only -247k workers, during the month of July, much less than the consensus of -330k. In addition, the unemployment rate dropped for the first time in over a year, coming out at 9.4%. Even though the results showed that U.S workers are still losing their jobs, due to the economic situation and global slowdown, the results increased investor’s confidence, showing that the trend in jobs market has presented a dramatic change.
As shown in the “NFP eye opener, leads to a USD curve ball” report, the U.S job market has now formed a lower-high, above January’s lows. In addition when taking a glance at the chart below one can see that while the NFP numbers are showing a dramatic improvement, so is the angle of the unemployment rate – flattening out, showing signs of stability. According to recent numbers July’s rate, showed slight improvement, coming out equal to May’s number of 9.4%.
What does this mean for Stocks?Many bullish investors were anxious to see the employment figures last week, hoping to receive fundamental backing to support the recent equity rally. On Friday, their expectations were fulfilled as the better than expected report sent the indices to higher ground. The S&P500 closed the week above the 1000 mark for the first time in over one year, at 1010.48 points. Even though the recent equity rally has shocked certain investors, some bullish ones are claiming that this is only the start of a nice bullish run, especially as the recent rally has been fueled by smart money and not by the broader market. One must note that recent price action in the Financial and housing sector is now beginning to show that the markets could be starting a new economic cycle. When taking a glance at the chart below, one can see the recent turnaround in the two sectors, exceeding others in relative strength. It is a common to think that the financials and the housing sector lead the start of a new bull market, as they respond well to low interest rates.
From a technical point of view the Financial sector (XLF) presented an impressive 10.3% gain last week, blasting through major resistance accompanied by increasing volume. The major mover of the week was AIG, helping to fuel the rally. In addition, European stocks also helped to drive the sector higher as Barclays and HSBC both recently showed impressive results for the second quarter.
If everything is so good, why did the Dollar Rally?Friday’s result sparked major movement on the Forex market, as the Dollar index increased dramatically during the intraday session, to close with a gain of 1.25%. On individual pairs, the EUR/USD and the GBP/USD both dropped while the USD/JPY, presented a sharp move higher breaking its downtrend resistance line. What shocked most traders was the sudden direction of the Dollar, especially as risk appetite has been associated with Dollar selling. Could this situation now be changing? Is the Dollar, S&P500 now losing its negative correlation? Even though it is too early to determine any major change in trend, especially as the Dollar is still trading in a down trend, fundamental data could be turning, something that could help the Dollar, at least in the short term.
Since 2002 the Dollar has been trading in a major down trend characterized by short secondary up trends, due to various chaotic events. For example the Dollar rallied towards the end of 2009 as investors fled from one of the worst recessions in over 3 decades, seeking safe-haven in the Dollar. Despite what most people think, there are a few reasons behind the Dollar’s long term devaluation, most of which stem from the U.S’s culture of consumption. Even though the major problem started back in 2002, when the Bush administration encouraged the U.S economy to fuel itself on spending, the rate of consumption exceeded normality within only a couple of years, causing the U.S to accumulate an astonishing trade deficit. Up until the start of the current recession, imports exceeded exports to such a degree that the level of consumption had to be supported by additional Dollars, some of which came from large foreign nations. This vicious circle, forcing additional Dollars into the system, had a tremendous affect on the value of the Dollar forcing it into a tailspin. In addition, adding to the equation declining investor’s confidence in the greenback, the Dollar lost further value as countries preferred to seek alternative investments, rather than assets pegged to the Dollar.
Despite the mega downtrend, fundamental data in the U.S has recently shown a promising situation, something that could help to drive the Dollar higher in the short term. When analyzing bonds one can see that longer term government yields are now climbing higher, in anticipation that the current rate levels and recent monetary actions could lead to future inflationary pressures. When observing the 10 yield note one can see the recent increase from January’s lows. If analysts are correct stating that the U.S could be one of the first to exit the current recession, presenting healthy economic growth and tolerate inflation levels, could the Dollar rise on strong fundamentals, especially when other developed countries such as Japan, England and Europe are still showing a gloomy economic picture?
As stated above, Friday’s price movement surprised investors hinting that the Dollar could now start to climb, together with a rising stock market. Even though major resistance levels are still yet to be broken before any definite conclusions can be drawn, skeptics are still doubtful that the rise will be anything more than a minor surge, especially if the U.S economy regains strength returning to its previous ways of consumption. Will rising consumption limit any Dollar rally, as experienced in the past?
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