USD: Risk off/risk on is likely to remain a key driver – MUFG

A modest rebound in the value of the US dollar is underway from heavily oversold levels, argue analysts at MUFG Bank. According to them, the negative correlation between the performance of the greenback and US equities remains elevated since the COVID-19 shock hit. 

Key Quotes: 

“USD performance continues to be driven primarily by fluctuations in investor risk sentiment. From that perspective it is not surprising that the USD started to rebound in the days following the recent peak in global equity markets on 8th June. The modest rebound in the USD so far is consistent with the modest correction lower in global equities.”

“The negative correlation between the performance of the USD and US equities remains elevated since the COVID-19 shock hit. The rolling 30-day correlation between the daily percentage changes in an equally-weighted basket of USD/G10 FX rates and the S&P 500 was at -0.56 as of yesterday. It has come down from a peak of just over -0.70 in the middle of May but remains high. It suggests that USD performance will continue to be driven by fluctuations in risk off/ risk on sentiment until the COVID shock fades further and there is more clarity over the outlook for the global economy.”

“While it is too early to conclude there has been a change in trading dynamics, it does represent potential upside risk for the USD. We expect the USD to rebound further in the near-term after becoming heavily oversold. Risk off/ risk on is likely to remain a key driver of USD performance but tentative signs of a stronger US economic recovery pose upside risks for USD.”