The falling US Dollar against other currencies is what's driving the stock market higher. From the chart above, as the dollar losses value (red line) US stocks gain in value (blue line).
Partly driving this unusual trend is the dollar's newfound status as one of the cheapest currencies to borrow among the developed nations. Thanks to the Federal Reserve's moves to drive interest rates to near zero percent, the U.S. dollar carries a low yield, particularly compared to currencies in Brazil and other emerging markets, where rates are much higher.
With U.S. rates on hold, more investors overseas are engaging in bets that the dollar will decline further -- in other words, taking short positions. Or, they're borrowing in the currency to buy higher-yielding assets just to profit from the difference between them, in what's known as the carry trade.
Other strategies may involve using a stronger currency such as the Euro and funding investments in the US stock market. Another reason for a higher stock market.
Result: We get a higher stock market when the dollar continues to fall. We get a lower stock market when the carry trade unwinds from the dollar moving higher.
Expect plenty of volatility going forward especially if we get a carry trade unwinding. Traders will have to cover their positions if the dollar rallies. To fund their losses or cover their margin call they will have to sell assets such as US stocks. The main reason for the inverse correlation when we see the dollar trend up.
Given what's driving the stock market higher, should you still be invested in this market? Maybe, if risk management strategies are used properly, such as automated hard stops, trailing stops, or portfolio hedging strategies. If a carry trade unwinding does occur, we could see stocks head lower in a hurry. Thank you for reading.
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