Below are the one-, three-, six- and twelve-month correlations for the seven major currency pairs.  Additionally, we have included the six-month trailing correlation for the majors against the EURUSD for a different view of correlation.

In order to be an effective trader, it is important to understand how different currency pairs move in relation to each other.  There are a few reasons why this is significant, but most importantly, it allows traders to understand their exposure.  For example, having a portfolio that consists of the EURUSD and AUDUSD is different than having a portfolio comprised of EURUSD and USDCHF.  Over the past few weeks, the market has seen stalwart economies come under pressure as financial and economic problems permeate the last vestiges of investor confidence. This has lead to a general diversion of flows to the benchmark US dollar and fading expectations for the Euro Zone regions. As such, we have seen the negative correlation between the EURUSD and USDCHF tighten (-0.85) as fundamental traders expect Switzerland to fall into the same trouble that the Euro Zone is slipping into. A similar brand of sentiment has been applied to the Australian dollar as its economy tumbles and interest rates fall quickly to earth. With risk aversion on the rise and the dollar’s safe have status growing, we have seen the positive EURUSD and AUDUSD relationship further tighten as well (0.77). From a trading perspective, this means that having long exposure in both EURUSD and USDCHF would generally negate profit or loss because when EURUSD rallies, USDCHF will sell off the majority of the time.  Of course, these two currencies may have different pip values and the correlation is not perfect, so the P/L will not be exactly zero. Alternatively, holding long EURUSD and AUDUSD positions would be akin to nearly doubling up in one of the pairs since the correlation is so strong. 

Furthermore, we can tell from our tables that correlations depending on our time frame.  Over the past month though, shifts have been more subtle, suggesting the market is consolidating and fundamental concerns in risk and growth far more pervasive across the markets. One of the most notable shifts was in the relationship between USDJPY and USDCHF. Both the yen and swiss franc have long been considered safe havens due to the interest they garnered back in the carry trade build up. However, as deleveraging ebbs and true fundamentals shine through, we have seen the relationship between the two drop from a positive 0.46 over the past three months down to 0.24 through February alone. It will be important to watch the development of this relationship over time as it will indicate whether the shift in these two currencies’ fundamental roles is merely temporary or if it will be a permanent change.  Overall, having this knowledge will allow traders to effectively diversify and manage their portfolios.

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 03/02/09)

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Questions? Comments? You can send them to John at jkicklighter@dailyfx.com.