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Investing.com - A rise in dollar-equity correlation this year could mean that the greenback is no longer a strong diversifier for stock portfolios, according to analysts at JPMorgan Chase (NYSE:JPM).
In a note to clients, the brokerage flagged that weekly returns of the dollar index, which measures the greenback against a basket of currency peers, and the MSCI World Local index are showing increasingly -- albeit mild -- positive correlations.
On a scale of correlation coefficients from -1 to +1, a positive figure typically indicates that two assets tend to move in the same direction.
The coefficient was in negative territory in the post-pandemic period until last year, the analysts led by Nikolaos Panigirtzoglou said, flagging that there have also been scattered periods of below-zero correlation since the 1980s.
"In other words, this year’s rise in the dollar-equity correlation towards zero or mildly positive territory looks more like normalization rather than an emergence of a new and unusual regime," the strategists wrote.
While this could imply that the dollar may not provide as much of a benefit as a diversifier for equity investors, the analysts said it is important to emphasize that the level of the dollar-equity correlation "matters as much as the sign." At levels at zero or just above, the range in 2025 is subsequently "too low to meaningfully amplify the volatility of a currency-unhedged U.S. equity portfolio."
In theory, this reduced diversification benefit could prove to weigh on the dollar going forward, the analysts added. However, there has been little evidence historically that shifts in dollar-equity correlation created headwinds for the dollar, they argued.
"We suspect one reason is that the decision over whether to hedge currency risk in an equity portfolio is not a straightforward one," they wrote. "Unless the dollar-equity correlation turns persistently and decidedly positive for a prolonged period of time, such as the 0.2-0.4 range seen from the mid-1980s to 2007, the hedging of currency risk in an equity portfolio looks unlikely to provide a meaningful and sustained reduction to overall volatility."