Forex Markets Increasingly Correlated to Dow Jones, Oil, Financial Market Duress

In fact, the correlation between the Euro/US Dollar pair and the Dow Jones has picked up significantly through recent trade—emphasizing the inter-connectedness of major financial markets and currencies. We likewise see that major forex pairs are increasingly correlated between themselves, and such an effect tells us that US Dollar and Japanese Yen have been the primary movers of forex market volatility through recent trade.

Forex Correlations Summary

Forex correlations against Oil, Gold, and the Dow Jones Industrials Average for the past 20 trading days:

Strongest Forex Correlations

US Dollar/Japanese Yen and the US Dow Jones Industrials Average The correlation between the US Dollar/Japanese Yen pair and the Dow Jones Industrials Average is currently near its highest in at least 10 years, as increasingly risk-averse markets dominate price action in the USDJPY. Every downward move in global equity indices encourages traders to close short positions in the low-yielding Yen—fully consistent with the broader theme of financial deleveraging. Continued losses in the Dow and other major markets would likely lead to further JPY rallies.
Australian dollar and the US Dow Jones Industrials Average The relationship between the highly risk-sensitive Australian dollar and the US Dow Jones Industrial Average has reached nearly-unprecedented levels. The broader theme of financial market deleveraging has hit the otherwise commodity-sensitive currency especially hard. Given sharp coincident declines in commodities and stock markets, many traders have had little choice but to close previously-profitable Australian dollar positions. Further deleveraging across all asset classes will likely continue to affect the Aussie dollar and make it sensitive to moves in the Dow.
Euro/US Dollar and Japanese Yen The Euro and Japanese Yen have had an increasingly negative correlation due to the fact that they stand on opposite ends of the global leverage spectrum. On one side, we saw that traders increasingly borrowed Japanese Yen at a low interest rate to fund investments in other currencies. On the other, we saw that leveraged investors aggressively sought profitable investments in the previously high-flying Euro. Thus aggressive financial deleveraging—much like we saw at the end of the tech bubble burst in 2001—has actually made the JPYUSD and EURUSD negatively correlated despite their common USD base.

Weakest Forex Correlations

Euro/US Dollar and the Price of Gold Gold has lost much of its correlation to the US dollar and the Euro/US dollar pair, as global risk aversion has become the main driver of gold price action. Continuing with the theme of broader market deleveraging, we see that the gold has actually lost much of its attractiveness as a hedge against broader financial market turmoil. This has made it increasingly uncorrelated with the US dollar, as the Greenback has very much benefitted from continued bouts of financial market duress.

Written by David Rodriguez, Quantitative Analyst for DailyFX.com

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