Something unusual is happening in US financial markets

Andrew Savulich/NY Daily News Archive via Getty Images
  • The positive correlation that existed between the US dollar index (DXY) and US treasury yields last year has now turned to dust.
  • Traders are bullish on the US dollar index and US treasuries right now, something Morgan Stanley says is “rare”.
  • The last time this occurred volatility in developed market currencies exceed that in emerging market currencies for nearly a year.

Something unusual is happening in US financial markets, at least compared to recent history.

Having moved more often than not in same direction over the past year or so, the positive correlation that existed between the US dollar index (DXY) and US treasury yields has now turned to dust.

“It is commonly thought that a higher US Treasury yield should come along with a stronger USD, but we don’t observe that today,” says Sheena Shah, FX Strategist at Morgan Stanley.

“The one-year correlation between the US dollar index, or DXY, and the US 10-year treasury yield has fallen to zero from a very positive level in June 2017.”

Morgan Stanley

So why has the positive relationship between the two come to a halt this year?

Shah says it reflects that traders, at least based on the collective positioning in futures markets, are currently bullish on both the DXY and US treasuries, the latter implying an expectation of lower interest rates.

“Over the last week, futures traders have been getting increasingly bullish on US rates, expecting lower yields, while remaining extremely bullish on USD,” she says.

“Rates and FX being extreme bullish at the same time is rare.”

And while past performance is not indicative of future returns, that combination could see volatility in developed market currencies exceed that in emerging markets in the period ahead.

“The last time that occurred was in late 2014,” says Shah. “[On that occasion], FX volatility in developed markets exceeded that in emerging markets for almost a year.”

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