The USD tends to rise when global or geopolitical fears are on the rise, serving as a safe haven, and fall when such fears subside. What to use to measure the level of fear or perceived risk in markets? There are several but I like to use the TED spread or the St. Louis Fed Reserve Financial Stress Index. More often than not, these types of sentiment measures tend to correlate so you don't need to use a bunch of them as they tend to convey the same message.
The TED spread is the difference between the 3-month LIBOR and 3-month T-bill yield. The lower the number, the less inferred risk of bank defaults and overall stress in the financial system.
As you can see above, the TED spread has generally hovered around 30-50 bps, but understandably rose above 100 bps during the financial meltdown of 2007-2008. Since the start of last year, the TED spread has been in steady decline and currently resides at 22 bps, a relatively low number implying low default risk and in general a low level of investor fear and anxiety.
As you can also see in the exhibit above, the US dollar tends to move with the TED spread. It's not a prefect correlation (what ever is?), but generally as the TED spread rises, so does the USD, and vice-versa.
However, for the past 12+ months, the TED spread has been declining and yet the USD has been in somewhat of an uptrend.
It's quite a disconnect. The following chart shows it starkly, with the USD (yellow line) far above the area of the TED spread (blue).
I do not pretend to know the reason(s) for why this is occurring, just that it's seemingly not an ordinary occurrence. I have not been able to decipher which tends to lead the other: does the USD tend to move before the TED spread, or vice-versa? Looking at the longer-term chart going back to 2003, it appears the TED spread might lead the USD, but again nothing conclusive. Note that last year the USD rallied and yet the TED spread was declining, and from July to September the USD fell pretty hard. That would suggest the USD is elevated and should correct given the current low TED spread.
I thought I'd also show the USD versus the St. Louis Fed Stress Index, pretty much the same picture.