January Effect for the US Dollar against the Euro

Noteworthy S&P 500 and Dow Jones Industrial Average declines through the month of January signal that stocks may yet again move lower through year-end, and the negatively-correlated US Dollar and Japanese Yen stand to gain from any such declines. The “January Effect” for the US S&P 500 and Dow Jones Industrials Average has shown January performance tends to predict rest-of-year moves with reasonable accuracy. Given dynamics in financial market risk sentiment and their effects on the safe-haven US Dollar, we expect any especially sharp declines to boost the low-yielding Greenback.

A 60-year study in the US S&P 500 (1950-2009) has shown that January performance predicts the direction of performance for February-December in 44 out of 60 years. In other words, a loss or a gain for the month of January has predicted the same from February-December with 73.3% accuracy. Any responsible statistician would tell you that correlation does not imply causality, and this could be mere coincidence. Yet the evidence is difficult to deny, and a decline through the month of January sets the stage for similar declines through year end.

The major caveat for this thesis is that it is anything but foolproof. In fact the S&P 500 2009 saw a substantial 12 percent decline through January, 2009 and nonetheless posted 30+ percent gains through the remainder of the year. Financial market volatility in the past three years makes it painfully clear that one should always expect the unexpected. In 2009, the S&P 500 and other major financial market risk barometers essentially crashed to significant lows through March. Yet a substantive risk sentiment recovery through year-end showed that quite literally anything can happen.

Regardless, recent financial market correlations have made it very clear that the safe-haven US Dollar and Japanese Yen stand to gain quite rapidly on any such declines in the S&P 500.

The charts above show the 250-trading day (approximately 1 calendar year) correlations between the Euro/US Dollar and Australian Dollar/Japanese Yen currency pairs against the US S&P 500. It is relatively clear that said correlation jumped substantially through the market turmoil in late 2008, and any such downturn through 2010 would likely be met by a similarly strong link between the Euro/US Dollar, Australian Dollar/Japanese Yen and S&P 500.

January Effect for the US Dollar against the Euro

A January affect appears to exist for the EURUSD exchange rate as well.  Performing the same study with the EURUSD since 1980 (synthetic rates pre-Euro) shows that January performance predicts the direction of performance for February-December in 20 out of 29 years. In other words, a loss or a gain for the month of January has predicted the same from February-December with 70% accuracy. Interestingly, the prediction has failed to materialize for the past 3 years.  Perhaps the January prediction is ‘due’ to work this year (the EURUSD is down nearly 2.5% as of the 01/28 close). 

Moreover, there is a tendency for the EURUSD to make its high or low for the entire year in January. Since 1980, the high for the year has occurred in January 11 times (37.9% of the time), most recently in 2005 (years in which the high occurred in January are bold-faced in the above table). For those years, the average decline (open to close) is 10.77% (-12.60%, -11.78%, -5.83%, -12.84%, -11.38%, -6.73%, -14.29%, -14.03%, -5.61%, -12.60%). The EURUSD opened 2010 at 14300 and a 10.77% decline from that point results in the EURUSD at 12760.

Keep in mind that analysis and trading are probabilistic exercises and that therefore nothing is foolproof. Still, one must consider the possibility that the EURUSD has already made its high for all of 2010.