The general belief is that when the domestic equity market in a country is strong, the economy of a country is strong, then its currency will be as well. Thus, one might think that if stocks in a particular country are rising, then it is reasonable to expect that the currency in that country will also rise. Foreign investors will pour their money into those markets and increase the demand for that country’s currency.
It all sounds so easy in theory, but the reality of the situation is often more complex.
For an easy example… The relationship between the U.S. Dollar and the S&P 500 has not been historically correlated. In many instances in the last twenty years, the two have moved together, moved opposite of one another, and have had no real correlation at all.
This shouldn’t lead you to think that there is no relationship between the two at all. It simply means that you need to know when the connection between the two is strong and when it is not.
Check out the correlation between the Dow (blue) and the Nikkei (orange):
Interestingly, the correlation between stock markets might be a stronger connection than between markets and their respective currencies. The Dow Jones and Nikkei exchange have moved in tandem with one another for roughly the last twenty years. They have carried very similar paths over that time, which tends to happen in most nations’ equities markets.
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