As an EU based investor in US equities, i keep my eye on the â¬/$ exchange rate. I have noticed that the $index generally moves in the opposite direction to US stocks (more or less) So, when US stocks are rising, the $ is falling and vice versa. I would have thought that if US stocks are being sold, then some of the selling would be by foreigners and so the US$ should also fall somewhat. I have not researched this, only observing recent 6 month or so movements, so don't know how long this has existed I'm sure this is a basic error i'm making. What am i not understanding here, any thoughts please?
Yes, the inverse relationship has been quite pronounced, however it hasn't always been the case. And unfortunately, there's no simple explanation for this. What may partly explain this is that when stock go up there's more optimism and US investors buy foreign stocks so they sell USD. On the other hand, when stocks are falling then there's flight to safety of the home currency... As a EU-based investor/trader it has been a dream playing the short side in the US stocks. These relationships work until they don't. Take USD vs. Gold, for example, generally it is assumed that the two move inversely, but there have been numerious occasions when the two moved in tandem.
One of the other possible explanations for the correlation is the size of the passive index funds. For example, I could invest in a global equity portfolio that tracks one of the global MSCI indices. A fund manager for such a fund would need to sell USD every time the USD equity mkt performs strongly. This rebalancing normally occurs at month end and could explain some of anti-correlation. On the other hand, there's a few other factors in play, as the previous poster suggested.