[FOREX 101] BDSM : Bonds, Dollars, and Stock Market

Stocks

Stocks are microeconomic securities, rising and falling in response to individual corporate results and prospects, while currencies are essentially macroeconomic securities, fluctuating in response to wider-ranging economic and political developments. As such, there is little intuitive reason that stock markets should be related to currencies. Long-term correlation studies bear this out, with correlation coefficients of essentially zero between the major USD pairs and U.S. equity markets over the last five years.

The two markets occasionally intersect, though this is usually only at the extremes and for very short periods. For example, when equity market volatility reaches extraordinary levels (say, the Standard & Poor’s loses 2+ percent in a day), the USD may experience more pressure than it otherwise would — but there’s no guarantee of that. The U.S. stock market may have dropped on an unexpected hike in U.S. interest rates, while the USD may rally on the surprise move.


Bonds

Fixed-income or bond markets have a more intuitive connection to the forex market because they’re both heavily influenced by interest rate expectations. However, short-term market dynamics of supply and demand interrupt most attempts to establish a viable link between the two markets on a short-term basis. Sometimes the forex market reacts first and fastest depending on shifts in interest rate expectations. At other times, the bond market more accurately reflects changes in interest rate expectations, with the forex market later playing catch-up.

Overall, as currency traders, you definitely need to keep an eye on the yields of the benchmark government bonds of the major-currency countries to better monitor the expectations of the interest rate market. Changes in relative interest rates (interest rate differentials) exert a major influence on forex markets.