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Forex Correlations: Europe, Spain Remains in Focus; Overall Risk Appetite Diverging by Region

Forex Correlations: Europe, Spain Remains in Focus; Overall Risk Appetite Diverging by Region

2012-10-27 00:20:00
David Liu, Technical Strategist
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Speculation over the outcome of Spain’s request for a bailout at this turn in the European Sovereign Debt Crisis continues to drive movements in the FX market. While in general the markets continue to trade in a risk-on, risk-off environment with an eye towards possible central bank easing from the Federal Reserve, European Central Bank or the Bank of Japan, correlations are returning to a state of being more correlated by their particular regions. As sentiments cautiously rise over the possibility over an EU plan to save Spain, thus reducing risk of a default and providing more liquidity to the market, traders are shifting capital towards European currencies and forgoing too heavy buying of higher yielding, but bound to the Chinese economy, Australian and New Zealand dollars.

The most notable change in correlations is that of the Euro versus the Aussie and Kiwi, dropping from around 70% to around 25%. While 1 year correlations remain strong, showing the effects of market-wide risk flows, shorter term correlations have dropped from previous record. In part, this is due to notable easing by the ECB during the summer months, which inflated the Euro and led to weakness against almost all counterparts, including the Australian and New Zealand dollars. Yet, with new Euros originating from lower ECB rates and other funding mechanisms entering the market at the time, EURUSD and AUDUSD closely tracked each other, supported by risk appetite.

In recent months however, as ECB easing speculation waned, questions about the Spanish government’s solvency started to appear on the markets. While the government of Mariano Rajoy have taken austerity measures to reign in government spending, the combination of low growth, worsening macroeconomic data and rising sovereign yields which increases the difficulty of Spain borrowing from the open markets, have heightened the probability of the government eventually requesting a bailout from the EU.

Although the size of Spain’s bailout (which includes EUR 60 billion for the nation’s banking system) is still under final debate, expectations for a fully-fledged rescue once Spain requests it has powered the Euro and Pound to new nights, outperforming other risk currencies. As a result, correlations between EURUSD and GBPUSD have preserved their strength, while correlations between the Euro and other currencies have weakened.

Currency correlations between major economic regions remain robust. The Aussie and Kiwi lag the Euro as China continues to slow down without signs of major stimulus plans, while the Canadian dollar has outperformed following a pick-up in US economic recovery, while being countered by conflicting signals from the Bank of Canada. This dissonance between the rates of economic growth may indicate that the world economy has not started to fully recover yet, which brings back the possibility of large risk-averse shocks down the line. Even though the US economy is seeing green shoots from recent unemployment and GDP figures, major event risks from the European periphery and Chinese shift away from manufacturing to services will provide shifts back towards haven assets in the near future.

FX markets are expected to be relatively quiet in anticipation of Spain, Greece, the US presidential elections in November 6th and Chinese leadership change on November 8th. While the three main economic engines, US, EU and China, continue at different paces facing different problems, there will be plenty of opportunities to look forward to.

Regardless of your trading strategy and whether you are looking to diversify your positions or find alternate pairs to leverage your view, it is very important to keep in mind the correlation between various currency pairs and their shifting trends.

FX Correlations (data as of 10/26/12)

EUR/USD

AUD/USD

USD/JPY

GBP/USD

NZD/USD

USD/CHF

USD/CAD

1 Month

0.33

0.25

0.74

0.27

-0.98

-0.48

3 Month

0.57

-0.05

0.73

0.54

-0.97

-0.42

6 Month

0.62

0.02

0.71

0.60

-0.99

-0.57

1 Year

0.69

-0.17

0.72

0.66

-0.95

-0.62

AUD/USD

EUR/USD

USD/JPY

GBP/USD

NZD/USD

USD/CHF

USD/CAD

1 Month

0.33

-0.31

0.61

0.74

-0.37

-0.48

3 Month

0.57

-0.24

0.61

0.81

-0.56

-0.64

6 Month

0.62

-0.02

0.68

0.88

-0.62

-0.75

1 Year

0.69

-0.18

0.69

0.91

-0.67

-0.78

USD/JPY

EUR/USD

AUD/USD

GBP/USD

NZD/USD

USD/CHF

USD/CAD

1 Month

0.25

-0.31

-0.06

-0.28

-0.21

0.23

3 Month

-0.05

-0.24

-0.14

-0.26

0.03

0.13

6 Month

0.02

-0.02

-0.02

-0.08

-0.03

-0.11

1 Year

-0.17

-0.18

-0.10

-0.19

0.17

0.03

GBP/USD

EUR/USD

AUD/USD

USD/JPY

NZD/USD

USD/CHF

USD/CAD

1 Month

0.74

0.61

-0.06

0.62

-0.74

-0.47

3 Month

0.73

0.61

-0.14

0.64

-0.74

-0.46

6 Month

0.71

0.68

-0.02

0.68

-0.71

-0.63

1 Year

0.72

0.69

-0.10

0.66

-0.69

-0.62

NZD/USD

EUR/USD

AUD/USD

USD/JPY

GBP/USD

USD/CHF

USD/CAD

1 Month

0.27

0.74

-0.28

0.62

-0.32

-0.55

3 Month

0.54

0.81

-0.26

0.64

-0.52

-0.59

6 Month

0.60

0.88

-0.08

0.68

-0.60

-0.71

1 Year

0.66

0.91

-0.19

0.66

-0.63

-0.73

USD/CHF

EUR/USD

AUD/USD

USD/JPY

GBP/USD

NZD/USD

USD/CAD

1 Month

-0.98

-0.37

-0.21

-0.74

-0.32

0.46

3 Month

-0.97

-0.56

0.03

-0.74

-0.52

0.42

6 Month

-0.99

-0.62

-0.03

-0.71

-0.60

0.58

1 Year

-0.95

-0.67

0.17

-0.69

-0.63

0.57

USD/CAD

EUR/USD

AUD/USD

USD/JPY

GBP/USD

NZD/USD

USD/CHF

1 Month

-0.48

-0.48

0.23

-0.47

-0.55

0.46

3 Month

-0.42

-0.64

0.13

-0.46

-0.59

0.42

6 Month

-0.57

-0.75

-0.11

-0.63

-0.71

0.58

1 Year

-0.62

-0.78

0.03

-0.62

-0.73

0.57

Date

EUR/USD

AUD/USD

USD/JPY

GBP/USD

NZD/USD

USD/CHF

USD/CAD

3/31/2012-4/30/2012

1 Month Trailing

0.59

-0.11

0.75

0.61

-0.99

-0.35

4/30/2012-5/31/2012

1 Month Trailing

0.52

-0.21

0.48

0.46

-1.00

-0.41

5/31/2012-6/30/2012

1 Month Trailing

0.76

-0.03

0.66

0.74

-1.00

-0.69

6/30/2012-7/31/2012

1 Month Trailing

0.74

0.39

0.73

0.67

-1.00

-0.82

7/31/2012-8/31/2012

1 Month Trailing

0.61

-0.03

0.73

0.67

-1.00

-0.38

8/31/2012-9/30/2012

1 Month Trailing

0.71

-0.18

0.83

0.60

-0.94

-0.40

9/26/2012-10/26/2012

1 Month Trailing

0.35

0.30

0.73

0.31

-0.98

-0.48

Average

0.61

0.02

0.70

0.58

-0.99

-0.50

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