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Forex Correlations Signal Euro/US Dollar Outlook to Depend on Oil Prices

Tuesday, 02 September 2008 13:30:00 GMT  |  David Rodriguez, Quantitative Analyst

Recently dramatic declines in crude oil prices have quite clearly coincided with similarly large US dollar advances, and our correlation study suggests that the US dollar and Oil will continue to trade very much in tandem through short-term forex and commodities trading. In fact, the Euro/US Dollar’s 1-year correlation to NYMEX Crude Oil Futures currently stands at its strongest since the inception of the euro. Such dynamics suggest that we may have to watch outlook for gold, oil, and other key futures prices to gauge the likely direction of the US dollar against key counterparts.

Forex Correlations Summary:

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

 

Recently dramatic declines in crude oil prices have quite clearly coincided with similarly large US dollar advances, and our correlation study suggests that the US dollar and Oil will continue to trade very much in tandem through short-term forex and commodities trading. In fact, the Euro/US Dollar’s 1-year correlation to NYMEX Crude Oil Futures currently stands at its strongest since the inception of the euro. Such dynamics suggest that we may have to watch outlook for gold, oil, and other key futures prices to gauge the likely direction of the US dollar against key counterparts. On its own, our recent EURUSD technical outlook report shows that a short-term rally seems likely.

In terms of weakening correlations, it is interesting to note that the Australian dollar has virtually stopped tracking movements in the US Dow Jones Industrials Average. Given that the broader G10 Carry Trade has recently picked up its correlation to the DJIA, the fact that the AUDUSD is largely moving independent of the key risk barometer suggests that there are other more important movers of Australian Dollar volatility. Namely, we have seen interest rate outlook take center stage in forcing AUD moves, and the Reserve Bank of Australia’s first interest rate cut in seven years bodes poorly for the highly carry trade-sensitive currency. 

Strong Forex Correlations

Euro/US Dollar and Oil Futures The correlation between the EURUSD and NYMEX Crude Oil futures has recently hit its highest levels since the inception of the euro—underlining the importance of commodity prices in determining the trajectory of the US dollar.  It seems that the relationship between oil and the US dollar remains stable, and we would argue that it will be important to watch for any significant price moves in oil while trading the US dollar and vice-versa.
Australian dollar and Reuters/Jefferies CRB Index The relationship between the Australian dollar and commodity prices has never been stronger; a rolling 1-year correlation between the AUDUSD and Reuters/Jefferies CRB Index now trades at its highest since the Aussie became a free-floating currency in 1984. As is the case for the EURUSD, the fact that the US dollar itself is moving almost lock-step with oil futures explains a good deal of this dynamic. AUDUSD outlook will largely depend on outlook for key commodities.
Forex Carry Trade Basket and the US Dow Jones Industrials Average In our last correlations report we argued that the G10 Carry Trade was largely losing its correlation to the Dow Jones Industrial Average and other risky asset classes. Yet recent price action has reaffirmed that Carry Trade outlook continues to depend on the trajectory for the DJIA and broader stock markets.  One notable exception is the Australian dollar.

 

Weak Forex Correlations:

Australian Dollar and the Dow Jones Industrials Average After setting record-highs through late-2007, year-long correlation between the AUDUSD and Dow Jones Industrials Average has turned significantly lower. It seems that the Australian dollar has proven far more sensitive to movements in commodity prices and, more recently, interest rate outlook. Indeed, the AUDUSD has recently tumbled on forecasts that the Reserve Bank of Australia will continue cutting interest rates aggressively through the coming year.  The RBA recently cut its short-term benchmark rate for the first time in seven years, and central bank rhetoric suggests we may continue to see lower Australian dollar yields through the medium term.

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- Forex Technical Outlook for the Day Ahead

- Australian Dollar Forecast against the New Zealand Dollar

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