Stock prices dropped more than a percent last week, their worst performance since the end of June. No, it wasn’t a poor economic release that disappointed investors. Nor was it poor earnings releases from retail giants, or a dramatic change in monetary policy, either.

It’s all about the US Dollar and interest rates, and it has been all year.

The Dollar Index bottomed near 90 in the early part of 2021, and it’s been a juggernaut ever since . Previous multi-year highs near 100 offered little resistance on the index’s way to a mid-July peak around 109. That level also happens to be the 138.2% retracement from the 2017-2018 selloff.

Currency analysis tends to fall by the wayside for many market watchers, and it’s not hard to understand why. Moves in the Dollar often have little to no correlation with moves in stock prices, and the index can be range bound for years at a time. But if you haven’t been paying attention this year, it’s time to start. Equites are moving in tandem with the Dollar Index. Take a look:

Moves higher in the USD (inverted above) have coincided with selloffs in stocks. The correlation looked like it might be breaking down in June and July as equities rallied, but last week, the Dollar started a new leg higher. It seems that stock prices noticed.

The move to parity has dominated the headlines, but Dollar strength isn’t limited to the Eurozone. Relative to the Japanese Yen, the USD is setting 20+ year highs. And just last week, USD/CNY resolved higher after several months of consolidation. It’s at the highest level since 2020.

As important as currencies have been, they aren’t the only thing driving stock market returns in 2022. Interest rates have played a key role as well. Rapidly rising rates tend to be bad news for equities, and this year has been no different. When bond prices accelerated lower this year, stocks went with them. And what happened when rates reversed lower in the middle of June? Stocks ripped higher.

Unfortunately, the rally in bonds didn’t last. The 10 Year Treasury managed to move above its swing high from May, but it wasn’t able to hold it. With prices below a downward sloping 200 day moving average and momentum in a bearish range, we can be confident saying bonds are NOT in an uptrend. That’ll continue to be a headwind for stocks.

Correlations are a tricky thing. Sometimes they work, sometimes they don’t. A close relationship between two asset classes can last for weeks, months, or even years, and then it can end for seemingly no reason at all. Who knows how long equities, the Dollar, and rates will move in tandem? I sure don’t. But they’re moving together now. If we want to see higher stock prices, we need to see this USD strength start to fade and rates level off, or else these correlations have to break down.

Which one will it be?

Nothing in this post or on this site is intended as a recommendation or an offer to buy or sell securities. Posts on Means to a Trend are meant for informational and entertainment purposes only. I or my affiliates may hold positions in securities mentioned in posts. Please see my Disclosure page for more information.

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