Shifts in Risk Appetite Alter Currency Correlations.
There are fundamental links underlying the market which wax and wane depending on what the prevailing concern in the market happens to be. Comparing and contrasting a portfolio made of EURUSD and AUDUSD against one comprised of EURUSD and AUDUSD highlights this development.The following is our monthly correlations update for October. As we have stated time and again, correlations between different currency pairs will inevitably shift over time. Therefore, it is of utmost importance to keep abreast of these fluctuating relationships to fully understand your trades and portfolio. Below are the one-, three-, six- and twelve-month correlations for the seven major currency pairs. Additionally, we have included the six-month trailing correlation for the majors against the EURUSD for a different view of correlation. In order to be an effective trader, it is important to understand how different currency pairs move in relation to each other (and in conjunction to other markets). There are a few reasons why this is significant, but most importantly, it allows traders to understand their net exposure. Such exposure goes well beyond merely buying or selling too much of a single currency against its various counterparts. There are fundamental links underlying the market which wax and wane depending on what the prevailing concern in the market happens to be. Comparing and contrasting a portfolio made of EURUSD and AUDUSD against one comprised of EURUSD and AUDUSD highlights this development. Evaluating the correlations amongst the majors today against what they were just a few months ago or a year ago, we can see that there is far less consistency. What is the difference between those periods and today? Risk appetite. Just a few months ago, demand for return and lack of financial turmoil was offering a boost to all securities that were particularly high or low on the risk scale. A year ago, things were exactly the opposite with all-consuming fear driving all markets lower. Today, the outlook for capital appreciation has leveled off and the binding influence of risk trends has begun to breakdown. Nonetheless, we can see the market is ready to revive its ties. Holding its reserve currency status the US dollar has seen its anti-risk role shift against currencies that are at different levels of the scale of return. In turn, the correlation between EURUSD and AUDUSD price action over the past month has cooled (0.74). At the same time, the Swiss franc's relative role of safe haven hasn't prevented significantly diminished the tight relationship of EURUSD and USDCHF price action (-0.94) - suggesting economic links are still a primary force in Forex speculation. For evidence of the ebb and flow in risk's influence over price action, we can see its correlation rise and fall over time. Establishing a base line of a six month trailing correlation, we saw last month the EURUSD and USDJPY correlation was tightening (-0.22) with a shift in risk trends towards growth concerns and a changing of the guard so to speak amongst the yen and dollar for the title of top safe haven. This was during the period when risk appetite was generally rising. Look back to the six months through March in comparison; and the dramatic change in risk trends essentially anchored the correlation near zero (0.08). Overall, having this knowledge will allow traders to effectively diversify and manage their portfolios over time. Regardless of your trading strategy and whether you are looking to diversify your positions or find alternate pairs to leverage your view, it is very important to keep in mind the correlation between various currency pairs and their shifting trends. FX Correlations (data as of 10/01/09) Written by: John Kicklighter, Currency Strategist for DailyFX.com Questions? Comments? Send them to John at email@example.com.
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|Date:||Oct 5, 2009|
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