By Kathleen Brooks, Brian Dolan

Forex markets function alongside other major financial markets, such as stocks, bonds, and commodities. Although these financial markets have seen higher long-term correlations with forex in recent years, short-term correlations are far less reliable.

But there are still important fundamental and psychological relationships between other markets and currencies, especially the U.S. dollar. In that sense, look to developments in other financial markets to see whether they confirm or contradict price moves in the dollar pairs.

So, even though there may not be a statistically reliable basis on which to trade currencies based on movements in other financial markets, you’ll be a step ahead if you keep an eye on the following other markets.

U.S. Treasury yields

U.S. government bond yields are a good indicator of the overall direction of U.S. interest rates and expectations. Focus on the benchmark ten-year Treasury-note yield as the main interest rate to monitor. Keep an eye on shorter-term rates, like three-month T-bills and two-year notes.

Rising yields tend to be dollar positive, and falling yields tend to be negative for the dollar. If yields are rising, but the dollar isn’t, it suggests that other factors are at work keeping the dollar down and that dollar bulls should be cautious. If yields are falling and the dollar is falling, too, you’re getting confirmation from the bond market of a negative U.S. dollar environment — lower interest rates.

Make sure you understand the reason for the bond yield’s movements, because it can suggest different interpretations. If it’s based on interest rate expectations — due to data or Fed comments, for instance — it’s more likely to reflect overall dollar direction.

If it’s due to market uncertainty and a flight to quality — due to European debt concerns, for example — the impact on the U.S. dollar may be more positive. The larger the change in yields, the more important is the message that’s coming from the bond market. Yield changes of more than 5 basis points (1/100 of a percent) should get your attention.

Gold and silver prices

Precious metals like gold and silver are typically viewed as hedges against inflation and safe-haven investments in times of financial market uncertainty.

In recent years, gold and silver have seen heightened demand as alternatives to the major currencies, most especially the U.S. dollar, but also the euro, as the European debt crisis has threatened the single currency. As such, gold and silver prices tend to move in the opposite direction of the U.S. dollar overall (inverse correlation), but the short-term correlations are trickier.

Gold and silver are relatively illiquid markets and mostly take their cues from the larger forex market, but the metals are no stranger to their own market-specific gyrations, typically based on breaks of technical levels.

Look for confirmation of the U.S. dollar direction in gold and silver prices. If the dollar is rallying and the metals are falling, for instance, it’s a good sign that the dollar’s gains are for real. If the dollar is rallying but gold is holding steady or even rising, the dollar’s strength looks more suspect.

Oil

Oil is similar to the precious metals and other commodities in that it has a long-term inverse correlation to the U.S. dollar (dollar down/oil up and vice versa). But the same caveat also holds true — shorter-term correlations are less reliable, and oil is especially vulnerable to oil-specific supply/demand shocks.

Note an asymmetric bias to the relationship between oil and the U.S. dollar. What that means is that oil is likely to experience greater strength on a falling dollar than weakness on a rising dollar, if all else is equal.

Look to oil price developments for what they suggest about interest-rate expectations and relative economic growth. Higher oil prices tend to increase inflation pressures, which may lead to higher interest rates. At the same time, higher oil prices tend to reduce economic growth by undermining personal consumption.

Between the two, oil’s impact on the growth outlook is more important due to the speed with which consumers react to changes in oil prices. Interest rate changes take longer. The recent surge in emerging market nations’ growth has also heightened global demand for oil, so oil increasingly functions as a barometer for overall global growth.

Stocks

Long-term, such as over the last decade, there is very little correlation between stock markets and currencies. However, since the Great Financial Crisis of 2008–2009, there has been a stronger relationship between stocks and forex, especially the U.S. dollar.

The relationship is best described as risk on/risk off, where stocks are considered risk-seeking assets and the dollar is viewed as the safe-haven asset, as investors buy USD to buy U.S. Treasury debt, the ultimate safe harbor.

In recent years, the risk-on/risk-off scenario has typically played out as follows: When the overall market environment is positive, investors embrace risk and buy stocks, reducing the demand for dollars, usually leading to dollar weakness. When the news turns bad, however, investors have dumped stocks and fled to the safety of U.S. Treasuries and the greenback.

As long as recent financial travails plague the global economy, this relationship seems set. But when economic and financial conditions begin to improve to something resembling normalcy, expect the stocks/forex relationship to return to lower historical correlations.