Do stocks hold the key to currency levels?

While prevailing wisdom dictates that stock markets and currencies usually move in tandem, that’s far from the case. What “should” happen often bears no resemblance to what actually happens, as myriad factors need to be taken into consideration. Every once in a while, we hear the stock market is falling because the dollar is falling, or the falling stock market will lead to a falling dollar, or rising currencies and rising stock markets elsewhere will lead to the dollar and U.S. stock market falling together.

You’d think that the linkage between two important asset classes such as currencies and stock markets would be straightforward, but it’s not. For one thing, both markets respond to many economic factors the same way, which is not to say a move in one causes the same move in the other. But they don’t move in sync on every factor. A rise in inflation and inflation expectations that is serious enough to trigger talk of rate hikes is currencyfavorable but stock market-negative. A stock-market crisis exacerbates existing confusion.

A stock-market crisis usually causes safe-haven flows into fixed income notes and bonds, driving the price down and the yield up. A rising yield favors the currency,
but so does the knee-jerk flow out of the crisis currency into a safe-haven currency. If a crisis in a foreign stock market causes a safe-haven flow into U.S. fixed income, by definition it’s also a flow into U.S. dollars. You’d have to be a forensic accountant to figure out how much flight capital goes into notes and bonds and how much goes into plain old dollar cash accounts.