The dollar’s positive correlation with U.S. equities may break this quarter due to a drop in its carry-trade appeal and a possible fiscal stimulus package.
Data from the last 10 years show the Bloomberg Dollar Spot Index has risen on average about 1.7% in the fourth quarter and the S&P 500 Index has advanced 1.9%, with the index usually outperforming its foreign counterparts. However, seasonal patterns seen in currencies have shifted in 2020 amid the onslaught of the global pandemic, and with this being an election year the correlations may break even further.
The stimulus will likely boost economic optimism, crimping demand for haven assets like the dollar. Also its carry-trade appeal — referring to borrowing in cheaper-financing currencies to invest in the greenback– has been undermined by the Federal Reserve’s easy monetary policy that pushed yields lower.
Should inflation rise because of the Fed’s dovish stance and increased stimulus, the greenback will suffer as real yields drop and shares may advance.
The relationship may also invert should a fourth quarter rally in shares be interrupted by the upcoming U.S. presidential election. In the month before the last three votes, the S&P 500 Index fell, while the dollar rose as investors rushed to haven assets amid a decline in risk appetite. President Donald Trump contracting the virus, possible shutdowns and concerns about a contested election could add to the uncertainty.