Can The U.S. Dollar Be Pro-Cyclical?

Factors behind the positive dollar/stock relationship from the late 1990s are no longer in place.

U.S Dollar Pro Cyclical

I n level terms, the rolling 26-week correlation between the trade-weighted dollar and U.S. equities is about to turn positive. But this is nothing out of the ordinary as it occurred for brief periods in the past and none of those previous episodes marked a structural return to a positive relationship. Our Foreign Exchange Strategy service argues that the fundamental factors that drove the dollar/stock relationship in the late 1990s are not in place today. A key reason for the positive correlation in the 1990s was the growing importance of foreign equity inflows, which tend to be unhedged.

Currently, government fixed income instruments account for the vast majority of capital flows into the U.S., and these flows are more likely to be hedged. If the U.S. current account deficit continues to reflect the large fiscal deficits, then foreign capital inflows must be largely into government fixed income securities, not into U.S. equities. This will make it difficult for a positive dollar/equity correlation to reassert itself. Also, in the 1990s, “risk on” meant buying U.S. tech stocks and therefore the dollar.

Today, the risky assets that investors want are outside of the U.S., particularly in emerging markets. So, when markets have a “risk on” bias, private capital leaves the relative safety of U.S. government securities for risky assets elsewhere; consequently, the dollar comes under pressure.

Bottom line: Over the last few weeks, both U.S. stocks and the dollar have managed to strengthen. We doubt that this is the start of a long term positive correlation like that seen in the late 1990s.

Corn: A Gloomy Picture In 2012

Global corn supply will expand while demand will falter in 2012. This is bearish for corn prices.

Corn Price For 2012

C orn prices were well above 600 cents per bushel most of last year. This was a reflection of a many factors including the Russian drought in mid-2010, the U.S. drought in 2011, rising corn use for ethanol in the U.S., and the boost in hog production in China. These factors should either disappear or diminish in 2012.

  • On the supply side, production is expected to increase in 2012 on the back of higher world acreage and a recovery in U.S. corn yields.
  • On the demand side, two major drivers of global corn consumption (U.S. ethanol expansion and rising protein consumption from China) will lose strength in 2012, according to our Commodity & Energy Strategy service.

At current ethanol and corn prices, ethanol producers’ profit is negative. Corn prices will fall as some producers start to cut production and/or go bankrupt. Also, last year’s boost in Chinese hog production may drive down pork prices in 2012, which in turn would undermine hog production and feed grain (mainly corn) consumption. The major risks to the bearish view are weather events (that could curtail supply) and an oil price surge (because it increases demand from corn-based ethanol producers).

Bottom line: Rising supply and faltering demand will replenish depleted global inventory and drive down corn prices. Corn prices are likely to drop to the range of 350-450 cents per bushel by the end of 2012 in the absence of major weather events and/or an oil price surge.