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Why Dow Record Could Be Good News for the Dollar

The Dow Jones average hit a record high on Tuesday, helped by better-than-expected service sector data for the U.S. Such risk-on appetite has traditionally had a negative correlation for safe-haven currencies such as the dollar.

John Corwin | Photo Researchers | Getty Images

But Ian Stannard, FX strategist at Morgan Stanley believes things will be different for the greenback this time, with global currency market dynamics changing quite rapidly.

"There's a very big change that is taking place," Stannard told CNBC. "As we start to see equity markets continue to move higher, the dollar could actually remain very well supported."

According to Stannard, the dollar is becoming an asset currency, instead of being a funding currency - a currency with a low interest rate used to buy one with a higher interest rate.

"Over the course of recent months the dollar has in fact become increasingly more positively correlated to asset markets and to new risk," he said.

"I think that is a real factor in the market which I think investors haven't really fully picked up on as yet. But I think it will be a feature over the coming weeks, a risk positive environment I think can be supportive for the dollar."

(Read More: Is the Dow the New Safe Haven?)

The dollar index rallied strongly in February but has taken a bit of a breather over the past week.

"The correlation in weekly changes between the S&P 500 and the DXY index are -43 percent, meaning that "risk on" tends to be negative for the dollar," Marshall Gittler, head of global FX strategy at IronFX said in a research note on Wednesday. "This perhaps explains in part why the dollar's rally has stalled."

(Read More: Why Dollar Is Looking Awfully Nice)

But Gittler too believes this is going to change. Capital inflows could switch to be more determined by the equity markets instead of bond yields and interest rate differentials, he said.

"Risk on could switch to being USD-positive if equity flows begin to dominate."

But for investors wanting to go long the dollar, some experts urge caution.

Jane Foley, senior currency strategist at Rabobank said the dollar could probably see a fairly "jittery" range against the euro over the next few months.

"Can the dollar really get an awful lot of traction when the Fed is printing so much money," she asked Wednesday.

(Read More: Is the Dollar Dying? Why US Currency Is in Danger)

According to Foley, the fact that the Fed continues to print so much money each month is a reassurance for the markets, adding that it was allowing investors to "iron over the cracks".

Foley believes that the Federal Reserve will continue its path of monetary easing at least until the end of the year.

"There are some downside risks from where we are today in euro/dollar but I think generally speaking we're going to be in a fairly jittery range. Because I think both those currencies are weakened by their economic fundamentals."

Currency investors will be nervously watching this week's key jobs data with the private-sector Automatic Data Processing (ADP)'s monthly report due first on Wednesday.

"The USD index is coming up against key resistance in the 82.50-82.80 range," Lloyds said in a research note on Wednesday. "The risk-on tone is also less likely to favor the USD against the EUR bloc. We would tend to fade USD strength from here unless ADP surprises on the upside."

By CNBC.com's Matt Clinch

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