Tale of Two Markets Before and After Pandemic: Economy Driven vs Dollar Driven

Abstract

The correlation between the U.S. equity market and the U.S dollar is intriguing yet complex. In this paper, we dissect the correlation into two opposing driving forces: purchasing power versus economic strength. A weak dollar inevitably will have a lower purchasing power, causing prices of all dollar denominated assets to rise creating an inverse relationship between the value of the dollar and the U.S. equity market. On the other hand, increasing strength in the U.S. economy will boost the confidence in the U.S. equity market and in the U.S. dollar, thus creating a positive correlation between the value of the dollar and the U.S. equity market. These two factors pull the correlation between the dollar and the equity market in opposite directions; whether the actual correlation is positive or negative depends on which factor is dominant in driving the equity market in a particular period of time: the economy or the value of the dollar. Using regression analysis, we discover that the correlation between the dollar and the equity market was negative and significant during the pre-covid period and becomes positive and significant during and after the pandemic period, suggesting that the market was economy-driven before the pandemic and became dollar-driven during the pandemic period.