Global Reserve Currencies
Image attribution: Spitzl. GFDL, CC BY SA 3.0
With the dollar still accounting for more than 60 percent of global reserve currency, its value has a significant impact on global trade including equity prices. Today the dollar index, a measure of the dollar's value against a basket of other currencies temporarily rose above 80 per Bloomberg. This financial relationship is clarified by Sentra Commerce that claims since the dollar impacts commodities prices, which then affect bond prices that affect equity prices. For example, if the dollar increases in value, then the price of oil drops because it is priced in dollars, and bond rates drop because interest rise with inflation, then stocks go down.
According to Investopedia Intermarket Analysis is an indicator not an immediate signal to buy and sell. In other words it can take time for the chain events to occur, and any break in the sequence nullifies or dampens the influence of the dollar on stocks. For example, a stronger dollar causes oil to drop, but a global event, or central bank decision can counteract that pressure. For instance, when the Federal Reserve Bank implemented massive open market operations it seemed as though the treasury market was influencing the currency price and not the other way around.
When the Federal Reserve expanded its balance sheet it was effectively lowering interest rates on government securities as demand causes price to rise and rates to lower. Since lower interest rates are not inflationary, yet massive central bank purchases are in terms of dollar valuation, the traditional sequence proposed by Intermarket Analysis is vulnerable to being misinterpreted. For this reason it is important to be aware of additional market and economic factors. Today the dollar rose in value, presumably because of Europe's financial crisis causing the Euro to decline in value. The effect of this is a short-term flight to safety such as U.S. Treasuries, and the dollar.
Is today's market action reflecting initial events or future results of the Intermarket price sequence? Or is it due to other factors such as overbought equities, increased rehypothecation of assets in international markets, or cash flow out of U.S. equities? In any given day it is the big picture, comprised of a multitude of related variables that causes the trading decisions of financial institutions and private equity firms to either buy or sell. Not all these decisions are based on the same time horizon, short-term traders take advantage of immediate price events, whereas long-term investors navigate a course. Still more do both.
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