- U.S. dollar is likely to be an outsized driver of risk: LGIM
- Correlation between currency, stock volatility is negative
The U.S. dollar is driving a wedge between volatility expectations for global currencies and U.S. stocks.
The greenback’s plunge last month jolted currencies so profoundly that a gauge of expected swings in the market is no longer moving in tandem with a similar measure for U.S. equities. So much so that the 40-day correlation between the JPMorgan Global FX Volatility Index and the VIX Index of U.S. stock swings fell below zero this month to the lowest since 2009.
“It’s a reminder that dollar moves could be an outsized driver of risk, sentiment and narrative over the next few months, if they continue with the recent volatility experiences,” said London-based John Roe, head of multi asset funds at Legal & General Investment Management. For equities, there’s a “feeling that the fireworks are over for now,” he said.
That’s because currency traders are anxious about the unknowns of the coming months and their impact on the dollar. The risks include the U.S. presidential election and the possibility that coronavirus infections may surge during the winter in the northern hemisphere, a factor that has played in the euro’s favor after European governments proved to be quick to implement mitigation measures.
And at the same time, implied volatility for equities dropped to the lowest since Feb. 21 on a closing basis as central-bank stimulus whitewashes a plethora of risks weighing on company revenue. Goldman Sachs Group Inc. joined other firms in raising its year-end target for the S&P 500 Index, which is close to a record high.
“The lack of correlation highlights the diversification out of U.S. dollar,” said Sophie Huynh, multi-asset strategist at Societe Generale in London. “The question is whether we will have the same move in equities.”