In today’s weekend update, we are looking at the disconnect with historic correlations between equities, bonds and the U.S. dollar.
There are common long term correlations between U.S. equities and commodities. Bonds and the U.S. dollar also have a historic strong correlation. Generally bonds and the dollar also move opposite of equities and commodities. Over the past couple of months we have seen a significant disconnect between U.S. bonds and the U.S. dollar. There are different reasons the correlation may be inversed. First, we could be seeing U.S. bonds purchases being driven by domestic entities and not by foreign entities. Secondly, we could be seeing a risk aversion or defensive move to bonds and away from the U.S. economy including the U.S. dollar.
Looking back historically, the times we have seen bonds (/ZB) and the U.S. dollar index ($DXY) maintain a monthly inverse correlation of more than 80% has been the times we have seen market corrections and recessions. When the U.S. dollar has lost ground and bonds have rallied this dramatically, it has been a warning 4 out of 5 times in the past 25 years of a market correction of more than 30%.
Keep in mind as well, as you can see in the chart, it was a warning in that this is a monthly chart and it can take months for equities to begin the selloff and though in the past 25 years it has been 80% accurate, it is still a correlation and not necessarily a causation. If bonds continue to rise and the U.S. dollar finds a base and starts to rise, this could be the indication of the next major market correction.