G10 FX Strategy: Does US Equity Outperformance Lead to a Stronger USD? Ask the Bond Market

Research evidence excerpt

G10 FX Strategy: Does US Equity Outperformance Lead to a Stronger USD? Ask the Bond Market

Global IdeaM

Currency & Foreign Exchange

USD | Does US Equity Outperformance Lead to a Stronger

USD? Ask the Bond Market

David S. Adams, CFA

MORGAN STANLEY & CO. INTERNATIONAL PLC

David.S.Adams@morganstanley.com +44 20 7425-3518

Andrew Watrous

MORGAN STANLEY & CO. LLC

Andrew.Watrous@morganstanley.com +1 212 761-5287

Molly Nickolin

Molly.Nickolin@morganstanley.com +1 212 761-3592

Koichi Sugisaki

MORGAN STANLEY MUFG SECURITIES CO., LTD.

Koichi.Sugisaki@morganstanleymufg.com +81 3 6836-8428

The strength of the US equity market – and the US economy – has dominated

conversations with investors. Indeed, it's not surprising given the magnitude of

outperformance of both ( Exhibit 1 ). For a growing chorus of FX participants, the

robustness of both the US equity market and the US economy is a magnet for capital,

which in their eyes should generate USD strength.

We don't disagree necessarily, but we think more nuance is needed. An outperforming US

equity market can lead to a stronger USD, but it needs wider rate differentials to

support the greenback. If US equities outperform while rate differentials tighten, the

USD weakens, not strengthens.

To explore this topic, we look at the historical performance of G10 currency pairs across

four scenarios when we condition on two outcomes: are US equities outperforming or

underperforming the local equity market, and are US-RoW rate differentials widening or

tightening? We explore using both 2y and 10y rate differentials.

Exhibit 1: US equities have outperformed global Exhibit 2: How does the USD perform conditioned

peers as economic data have surprised to the upside on equity and 2y rate outperformance or

underperformance?