Dollar bounce threatens everything else

A rise in the dollar could trigger a "stampede" as investors rush to cover short positions by selling risky investments.

Since early last year, there has been "a rock-solid relationship" between the dollar and risk appetite, says Jennifer Hughes in the Financial Times. Good news would fuel appetite for risk, weakening the dollar as investors sold safe US holdings to scoop up assets such as stocks or commodities. Bad news has prompted the sale of those assets and investors to seek a safe haven in dollars. The inverse correlation between US stocks and the dollar has been above 90% over the past six months (a 100% correlation would imply that the two trends were in lock-step).

Last Friday there was talk that the link might be ending. US employment figures were much better than expected: 11,000 jobs were lost in November, and the jobless rate fell from 10.2% to 10%. The dollar jumped by almost two cents against the euro, as markets brought forward the date they expect an interest rate rise, reversing the trend of falling on good news. If the Federal Reserve does raise rates, it may "dramatically alter the way the US dollar behaves", says M&G's Michael Riddell on Bondvigilantes.co.uk. Between early 2004, when the market began to price in a series of Fed rate hikes, and late 2005, the dollar gained almost 12% against the yen and 7% against sterling and 4% against the euro, at a time when stocks were also climbing.

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