Keep an Eye on Financial Markets
The forex markets operate in conjunction with other major financial markets, such as stocks, bonds, and commodities. Although these financial markets have seen higher long-term correlations with forex in recent years, short-term correlations are much less reliable.
But there are still important fundamental and psychological relationships between markets and other currencies, especially the US dollar. In this sense, look at developments in other financial markets to see if they confirm or contradict price movements in dollar pairs.
So, even though there may not be a statistically reliable basis for trading currencies based on moves in other financial markets, you will be a step ahead if you keep an eye on the following other markets.
US Treasury yields
US government bond yields are a good indicator of the general direction of US interest rates and the outlook. Focus on the benchmark 10-year Treasury yield as the key interest rate to watch. Watch for short-term rates, such as three-month Treasuries and two-year Treasuries.
Higher returns tend to be positive for the dollar, and lower returns tend to be negative for the dollar. If yields are rising, but the dollar has not, this indicates that other factors are keeping the dollar lower and that dollar bulls should be careful. If yields are dropping and the dollar is also falling, you get confirmation from the bond market of a negative US dollar environment – low interest rates.
Make sure you understand the reason for the bond yield movements, because it can suggest different explanations. If it is based on interest rate expectations – due to data or Fed comments, for example – it is likely to reverse the general trend of the dollar.
If it is due to market uncertainty and quality orientation – due to European debt concerns, for example – the impact on the US dollar could be more positive. The greater the change in yields, the more important the message that comes from the bond market. Yield changes over 5 basis points (1/100th of a percentage) should grab your attention.
gold and silver prices
Precious metals such as gold and silver are usually viewed as a hedge against inflation and as safe haven investments in times of uncertainty in financial markets.
In recent years, gold and silver have seen a surge in demand as alternatives to major currencies, especially the US dollar, but also the euro, as the European debt crisis threatened the single currency. As such, gold and silver prices tend to move in the opposite direction to the US dollar in general (inverse correlation), but short-term correlations are more difficult.
Gold and silver are relatively illiquid markets and mostly derive their signals from the larger forex market, but metals are no stranger to their own market volatility, which usually depends on breaking through technical levels.
Look for confirmation of the direction of the US dollar in gold and silver prices. If the dollar is rising and metals are falling, for example, this is a good sign that the dollar’s gains are real. If the dollar is rising with gold holding steady or even rising, the strength of the dollar seems more doubtful.
oil
Oil is similar to other precious metals and commodities in that it has a long-term inverse relationship with the US dollar (dollar is falling / oil is up and vice versa). But the same caveat is also true – short-term correlations are less reliable, and oil is particularly vulnerable to oil supply/demand shocks.
Note that there is an asymmetric bias in the relationship between oil and the US dollar. What this means is that Oil is likely to see more strength when the dollar falls than weaker when the dollar rises, all other things being equal.
Look at developments in oil prices to see what they suggest regarding interest rate expectations and relative economic growth. Higher oil prices tend to increase inflation pressures, which can lead to higher interest rates. At the same time, high oil prices tend to limit economic growth by undermining personal consumption.
Between the two, the impact of oil on growth expectations is more significant because of the speed with which consumers react to changes in oil prices. Interest rate changes take longer. The recent surge in the growth of emerging market countries has also increased global demand for oil, so oil is increasingly serving as a barometer of overall global growth.
Stores
In the long run, as has happened over the past decade, there is very little correlation between the stock and currency markets. However, since the great financial crisis of 2008-2009, there has been a stronger relationship between stocks and forex, especially the US dollar.
This relationship is best described as risk / no risk, where stocks are considered risk-seeking assets and the dollar is seen as a safe haven asset, where investors buy US dollars to buy US Treasury debt, the ultimate safe haven.
In recent years, the risk/no-risk scenario has been implemented as follows: when the general market environment is positive, investors take risks and buy stocks, which reduces the demand for dollars, usually resulting in a weaker dollar. But when the news got worse, investors dumped stocks and fled to the safety of US Treasuries and the dollar.
As long as recent financial troubles pummel the global economy, this relationship appears to be firm. But when economic and financial conditions begin to improve to something resembling normal life, expect the relationship between stocks and forex to revert to lower historical correlations.