Dollar Loses Appeal After Stocks Rebound and Haven Demand Ebbs

(Bloomberg) -- After reasserting itself in late January on the back of a global equities selloff, the dollar's strength has ebbed again this week as stocks found firmer ground.

A gauge of the greenback's strength posted the largest decline in two months Monday and extended its push lower Tuesday, as U.S. stocks wrapped their best three-day run since 2020. Before this week, the currency had gained in nine of the past 11 sessions against its major peers, advancing 2.2%, as investors looked for safety from a broad-based decline in risk assets.

While traders and fund managers had positioned themselves for the dollar to continue last year's run -- its best since 2015 -- on rising rates in shorter-maturity Treasuries, the correlation has eased in recent sessions. Two-year Treasury yields have climbed more than 40 basis points so far in 2022, while the Bloomberg Dollar Index has shed almost half of its year-to-date gains in the past two days.

A stalling of front-end yields near the 1.2% mark and an inability for rates markets to drive up expectations of Federal Reserve tightening in the near-term is helping contribute to the dollar's recent pullback, according to Simon Harvey, head of foreign exchange analysis at Monex Europe.

“The more settled nature of the U.S. rates market is definitely contributing to the overall improvement in risk sentiment and equity performance, and that is playing out in the FX space this week too,” he said. “It is almost as if markets are breathing a sigh of relief in unison after last week's repricing.”

Equity markets have rebounded in the past few sessions after fears of global monetary policy tightening contributed to one of the biggest stock routs in recent memory. The inverse relationship between equities and the dollar's strength has begun to re-establish itself after reaching its 2022 low last week, suggesting that improving risk sentiment could be pushing investors from the greenback's safety to riskier assets.

Still, investors closing their positions might be a simpler explanation for the greenback's moves instead of a newfound driver. After the dollar gained every session last week, some profit-taking should be expected, said Win Thin, head of currency strategy at Brown Brothers Harriman.

“Part of the dollar gains were likely due to some risk-off sentiment so that may be part of the softer dollar, too,” he said. “But I like U.S. rates and USD higher after this period of consolidation.”