Goldman: Is there a correlation between the weakening dollar and the decline in US stocks?

Goldman analyzed the relationship between the weakening of the US dollar and the decline of the US stock market, as well as how global investors responded to this market dynamic. On January 27, the market began to worry that the excess returns of US assets may be nearing an end, which could weaken the long-term strength of the dollar, as the "exceptionalism" of the US market depended on the value of the dollar. If this trend reverses, the dollar may weaken against cyclical currencies. Despite concerns about a slowdown in US economic growth, Goldman still believes that the dollar is unlikely to weaken persistently unless there are clearer signs of global economic recovery. 1. How does the decline of US stocks affect the dollar? It is rare for the dollar and US stocks to decline simultaneously, usually requiring a major market shock, such as credit tightening, a downward revision of US economic growth expectations, or an increase in credit risk. The collapse of Silicon Valley Bank (SVB) in March 2023 led to a brief weakening of the dollar against the Swiss franc (CHF) and the Japanese yen (JPY), but the dollar rebounded in the following month while US stocks recovered first. Historically, the double decline of the dollar and US stocks has been short-lived, such as market corrections in 2002, 2007, 2011, and 2016, which were mostly related to interest rate expectations or credit events. 2. How do investors respond to the weakening of the dollar? Japanese yen (JPY), Swiss franc (CHF), and euro (EUR) performed best when the dollar weakened, with Japanese yen being the best hedger. The euro (EUR) with its "risk-neutral" attributes performed relatively stably during market turbulence. Investors may consider longing the Japanese yen/dollar (JPY/USD) or Swiss franc/dollar (CHF/USD) pairs to hedge against a US stock market correction. 3. Future outlook: Will the dollar continue to weaken? Goldman believes that the dollar will not continue to weaken without a global economic recovery, as a slowdown in the US economy often spills over to the global economy, ultimately enhancing the dollar's safe-haven demand. If the market begins to downgrade US growth expectations, the Japanese yen and Swiss franc may become stronger safe-haven choices. If the Federal Reserve reverts to raising interest rates due to a rebound in inflation, the dollar may still strengthen, making longing the Japanese yen against the Australian dollar (JPY/AUD), New Zealand dollar (JPY/NZD), or British pound (JPY/GBP) a better hedging strategy. Goldman believes that the double decline of the dollar and US stocks is usually a short-lived phenomenon, and investors can use Japanese yen, Swiss franc, and euro to hedge risks. However, the dollar will not continue to weaken without a global economic improvement, so the focus should still be on the Federal Reserve's policy and global economic expectations. If the Federal Reserve reverts to raising interest rates or the US economic downturn spills over to the global economy, the dollar may still strengthen. #End of Polished Translation