Will the Dollar Fall in Line?

From the desk of Steve Strazza @Sstrazza and Ian Culley @Ianculley

The US dollar marches to the beat of its own drum.

Interest rates are rising across the curve, sparking strength out of economically sensitive areas within stocks and commodities.

Crude oil and the energy-heavy CRB Index are breaking to new six-year highs and the energy sector SPDR is testing a crucial area of former support turned resistance -- all while the US Dollar Index is catching a bid. 

It’s not every day we see the dollar and commodities rally in tandem.

This environment suggests the dollar should be rolling over or chopping sideways at best. Yet it continues to show strength!

When markets don’t do "what they should,” that’s valuable information. And in this case, it raises some important questions.

How often does the historically inverse correlation between the dollar and commodities decouple? 

And how long do these divergences in their relationship tend to last?

Let’s dive in to see if we can find some answers!

Here’s a chart of the US Dollar Index overlaid with the CRB Index and a 63-day correlation study in the lower pane:

The CRB and the DXY look like mirror images when overlaid. This inverse relationship is illustrated well by the correlation coefficient being consistently negative between these indexes.

But there are spurts of green in the lower pane too. They actually happen pretty often on shorter timeframes. These indicate times when the two actually sported a positive correlation over a trailing 63-day period.

As you can see in the chart, it actually does happen quite often. It just doesn’t last very long when it does. Nor does the correlation tend to hit extreme positive readings as it does during periods when the reading is negative.

Basically, the instances when these indexes move in the same direction are short-lived and seldom near the extreme levels associated with a meaningful correlation.

It just so happens we’re going through one of those times right now.

But we don’t think it’s cause for significant concern.

The weight of the evidence suggests that we want to trust the price action in commodities more than that in the dollar. 

With the dollar running into a confluence of resistance right now, what better place than here for it to catch lower and clear up this intermarket divergence.

And, as the correlation study suggests, the USD usually falls back in line -- it’s just a matter of when and which direction it takes.

The takeaway here is simple. In theory, with the dollar trending as well as it is, we’d expect commodities to be under pressure. The fact that they’re not is bullish in the sense that they're not doing "what they should."

Now, consider this: If commodities can rip higher with this dollar strength, imagine what they’re likely to do without it.

We hope you enjoyed this post!

Thanks for reading. As always, let us know what you think. 

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