Stock selloffs ignite dollar rallies

As terrified traders worldwide rushed to dump their stocks, they moved their capital into cash. There is nothing better to own in a rapidly-falling market, it preserves purchasing power to buy the resulting bargains after the intense selling burns itself out. Countless foreign traders, seeing their local currencies plunging with stocks, sold their own money to buy US dollars. Thus the US dollar skyrocketed, as you can see above.

The USDX itself, a measure of the US dollar versus six other major currencies (mostly the euro at 57.6% of its weight), blasted 22.6% higher in just 4 months! Realize that currencies usually move with all the sound and fury of a glacier, so this was a breathtaking extreme for the world’s reserve currency. This particular USDX rally was actually its biggest and fastest ever witnessed over such a short span!

The SPX and USDX inverse correlation over that red panic span is readily evident visually in this chart. This relationship holds up statistically too, sporting a very high 81.7% r-square. Nearly 82% of the daily USDX price action over that stock-panic span was directly explainable mathematically by the SPX’s own. The USDX even hit new highs on the same days the SPX hit new lows, both at the original October panic low and the secondary deeper November one. The dollar was slaved to the stock markets’ fortunes.

And then when the SPX finally started stabilizing in December, the USDX plummeted. There was no need for the safe-haven refuge of US-dollar-denominated cash with the stock markets clawing higher again. But then in January 2009, the stock markets inexorably started sliding lower again. This trend accelerated in February as the new Obama Administration haughtily asserted that American investors were undertaxed and the federal government was too small. The SPX spiraled lower in despair.

Once again the USDX soared as the SPX plunged, even exceeding its earlier panic highs. But as soon as the stock markets finally managed to bottom in March 2009 (I called this in real-time), the USDX started selling off again. The Fed’s announcement that it was starting to monetize US debt, its original gigantic quantitative easing, accelerated this plunge. Once again rallying stock markets negated the need for a safe-haven refuge in the US dollar, capital left to return to stocks.

Note that during that wildly-crazy stock-panic span, the only time the USDX rallied materially was when the stock markets were selling off. Then as soon as the SPX started rallying again, the dollar sold off. At the time, Wall Street argued that this USDX strength was due to the fundamental superiority of the dollar to other fiat currencies. Nonsense! The dollar only rallied when stocks sold off, it was a pure safe-haven play. There was nowhere else to go so traders nervously parked capital in zero-yielding cash.

Even though holding cash is very wise when stock markets are falling, that doesn’t mean the US dollar is either fundamentally-sound or a worthy long-term investment. It was a convenient shelter in an epic storm, nothing more. This surging dollar behavior during the panic conditioned traders to flee into the USDX whenever the SPX started selling off in the couple of years since.

A month ago I wrote an essay examining the extreme complacency and apathy in the stock markets today that guarantees a major SPX correction looms. In it I highlighted the pullbacks and corrections the SPX has weathered so far in its cyclical bull to date. These same seven SPX selloffs are highlighted below in red. Note what the US dollar did during each one. The panic-spawned phenomenon of rushing into this currency whenever stocks are weak is very much alive and well.

The initial several pullbacks in this stock bull were fairly small and short, and they happened early in the post-panic recovery when the stock markets were rebounding rapidly. So their resulting impact on the US dollar was minor. Yet note that this currency still rallied sharply in each of those initial SPX pullbacks. Then this SPX-driven dollar-rally model appeared to break in December 2009 when the dollar surged on its own accord.

Even though the dollar has been heavily influenced by the stock markets in recent years, it still has its own inherent technicals and sentiment. Occasionally they get extreme enough to overpower the stock markets’ dominating influence. And in late November 2009, the dollar was simply getting too oversold. Traders were too bearish on it and one of its periodic bear-market rallies was due. So one indeed erupted, but it soon petered out. Again the stock markets surged in early January 2010 and pushed dollar demand lower.

But then in mid-January last year, what would eventually grow into the largest pullback (less than 10% selloff) in this entire cyclical bull emerged. The USDX shot up sharply, topping the exact day the SPX bottomed just like we had seen during the stock panic. Traders were once again flooding into this currency for a safe-haven refuge during fast stock-market selloffs. Due to the irrational euro panic the dollar kept grinding higher in the subsequent months despite a stronger SPX, but its rally was very anemic.

Then late last April, the SPX started on what would prove to be its only full-blown correction (greater than 10% selloff) of this bull. What did the dollar do as capital fled overbought and complacent stock markets? It rocketed higher so vigorously that it actually neared its old panic highs despite a vastly higher SPX! And then literally the very day the SPX initially bounced in early June, the USDX topped. It started plunging until the next SPX pullback in August, when it again surged sharply.

Beginning in early September when the stock markets recommenced rallying, global traders again pulled their capital out of this safe-haven-currency parking spot and the USDX collapsed. It couldn’t manage another rally until the most recent SPX pullback erupted in November. Then of course right on cue, the US Dollar Index rocketed higher until the stock markets stabilized again. See the crystal-clear pattern here?

Nearly without exception, the only times the US dollar has rallied materially in the past few years was exactly during stock-market selloffs. With the Fed relentlessly creating new fiat dollars out of thin air like there is no tomorrow, and interest rates at zero, and Washington spending like drunken sailors, there is literally no fundamental reason to own the US dollar today. Traders only want it in one specific situation, when stock markets are falling fast so cash temporarily becomes king.

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