[Dan]

There have been various interesting Dollar correlations over the past year. First, early in the year, was the positive Dollar correlation with long yield differentials driven by the Fed’s aggressive QE policy in combating the recession. This was clearly evident in the EUR/$ movement with cross Atlantic long bond spreads. Next came a period of intense risk vs. Dollar negative correlation that really took hold in the Spring as risk sentiment improved, spurred by the improving industrial cycle. This was also mirrored in the return of the Dollar vs. oil negative correlation, as oil prices firmed on the back of improving global recovery prospects.

Going forward, market continues to expect the current risk vs Dollar negative correlation to persist. This is partly due to hedging asymmetries still being in place where FX hedge ratios tend to be higher for investments into low-yielding countries such as the US. Also, the US is still the epicentre of the global recession and the US consumer is arguably still the biggest concern for investors. Hence it is likely that investors are reluctant to buy US assets during bouts of risk aversion. But these trends should ease going forward.

Overall, we are generally still constructive on risk assets and we continue to see weakness of the Dollar in the near term. The next set of correlations that we may observe further down the road could be the positive correlation between the Dollar and risk assets, i.e., we may eventually see Dollar strengthen and risk rally at the same time, so a flip of the current risk vs Dollar negative correlations. This may occur as the powerful Dollar supportive structural factors of a much narrower US current account deficit, combines with a potentially improved capital inflow
situation, but this will probably not transpire until further down the business cycle.