fundamental alert

Forex Markets Remain Highly Correlated to Crude Oil, Gold, Dow Jones

Wednesday, 05 November 2008 16:00:00 GMT  |  David Rodriguez, Quantitative Analyst

Currency markets continue very highly correlated to oil, gold, and the global equity markets—emphasizing the widespread effects of ongoing financial market turmoil throughout almost all traded markets. Among the most notable correlations, the Japanese Yen has traded almost lock-step with the US Dow Jones Industrials Average; the correlation between the USDJPY and DJIA remains near its highest levels in at least 20 years.

Other noteworthy relationships include the increasingly tight correlation between the G10 Forex Carry Trade and the Reuters/Jefferies CRB Commodities Index. Given that financial deleveraging can affect all types of highly-leveraged markets, we see that many commodities have sold off and rallied at the same time as the FX Carry trade. A continuation of ongoing themes of financial market stress will likely keep these relationships intact through the foreseeable future.

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 20 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.
Forex Carry Trade and the Reuters/Jefferies CRB Commodities Index The correlation between commodity markets and the G10 Forex carry trade has never been stronger. Due to the highly leveraged nature of FX carry trades, they tend to sell off sharply in times of elevated market stress. Though commodity markets have not historically been as adversely impacted by market stress, we see that the previous run-up in Crude Oil and other prices led to a similar leveraging of commodity investments. For said reasons, it seems that the theme of global deleveraging may continue to affect both carry trade and commodity markets. p>
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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