Forex Correlations Emphasize US S&P 500 Key to US Dollar Forecast

Currency trading correlations to the US S&P 500, Dow Jones Industrials Average, and other financial market risk barometers have strengthened significantly. It will be critical to watch the S&P to gauge likely direction in the US Dollar and key forex counterparts.

The correlation between the S&P 500 and Australian Dollar/US Dollar currency pair has strengthened significantly through recent price action, and one only need to look at recent simultaneous AUDUSD and S&P declines for evidence of said fact. Similar price action in the Euro/US Dollar emphasizes that all eyes have shifted towards broader financial market risk sentiment, and the S&P’s next moves may prove critical in determining the strength of the recently-volatile US Dollar.

Forex Correlations Summary

Forex correlations against Oil, Gold, and the Dow Jones Industrial Average for the past 30 calendar days:

Australian Dollar and US S&P 500

The Australian Dollar’s link to the S&P 500 has strengthened considerably through very recent trade, seen most clearly in the AUDUSD’s dramatic decline on a similarly sharp sell-off in the equity index. Traders have sent the Australian Dollar to impressive highs as it boasts the highest short-term yield of any G10 currency and has benefited from record-highs in hard commodities prices. Yet one-sided AUDUSD bets emphasize that deleveraging could send stocks, commodities, and the Aussie Dollar lower as we saw on the Nikkei tumble. It will be critical to watch the S&P going forward.

Euro/US Dollar and US S&P 500

The Euro’s link to the S&P 500 has likewise strengthened as leveraged bets increasingly move in tandem across financial markets. Recent CFTC Commitment of Traders data shows that net Non-Commercial EURUSD longs have reached their highest levels since 2007, and such one-sided positioning warns that a rush for the exits could spark dramatic EUR losses. It will be very important to watch the S&P’s trajectory and broader moves in financial risk sentiment to gauge the likelihood of a more sustained EURUSD correction.

NYMEX WTI Crude Oil Contract and US S&P 500

The negative correlation between the US S&P 500 and Crude Oil remains near record strength as sharp oil price advances have often led to pullbacks in the S&P 500. Yet it has weakened from last week, when it hit its most extreme since early 2008. In fact, we may be seeing a similar trend to what we saw in early 2008. As market sell-offs intensified, the correlation between leveraged instruments such as Crude Oil futures and the S&P 500 became strongly positive. If the S&P continues to sell off sharply, we could see Crude Oil prices similarly fall from recent peaks.

Written by David Rodriguez, Quantitative Strategist for DailyFX.com

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