All Trade Ideas and trading scenarios found on FX360.com are hypothetical. FX360.com has not placed these Ideas in a live trading environment. Forex Trading involves high risks, with the potential for substantial losses that exceed your initial deposit and is not suitable for all persons. Past performance is not necessarily indicative of futures results.

Understanding The Forex- Equity Correlation

Last updated 12/22/2009 5:10 PM ET (GMT -5) 4 Comments

• Share this:

Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• UNDERSTANDING THE FOREX- EQUITY CORRELATION
• EUR/USD: CLOSING IN ON SUPPORT
• GBP/USD: UK ECONOMY REMAINS IN RECESSION
• NZD/USD: GDP MISSES
• USD/CAD: BUCKS TREND, EXTENDS GAINS AGAINST USD
• AUD/USD: LEADING INDICATORS FALL, GOLD LOWER
• USD/JPY: SIX DAYS OF PERSISTENT STRENGTH

EXPECTATIONS FOR UPCOMING FED MEETINGS

UNDERSTANDING THE FOREX- EQUITY CORRELATION

With the S&P 500 and Nasdaq hitting year to date highs, it should not surprise currency traders that the dollar has extended its gains.   Since the beginning of the month, the dollar appreciated more than 5 percent against the Japanese Yen and over 4 percent against the euro, Australian dollar and Swiss Franc.  The only currency that has been stronger than the greenback is the Canadian dollar and even then the loonie’s gains have been marginal.  Today, the loonie remains the only currency to strengthen against the dollar.  The correlation between the foreign exchange and equity markets continue to dominate trading but it is important to realize that this is a new development on a quiet trading week with unusually low volume and market participants.  

Understanding the Correlation Between Currencies and Equities

The correlation that everyone is focused on is the positive correlation between the dollar and stocks.  There is an expectation that the U.S. dollar and stocks will rise in tandem on the belief that investors in both markets are banking on an accelerating U.S. recovery.  It also means that the dollar is keying off U.S. fundamentals and not risk appetite as stronger U.S. data bolsters the confidence and attractiveness of dollar denominated assets.  Although this may seem logical to many investors, it has not been the case for most of the year. In fact the illogical behavior of the dollar selling off on good data and rising on bad has dominated trading.  The following table illustrates how the correlation between the S&P 500 and currencies has changed.  Between last Thursday and today, the S&P 500 has had a 96 percent negative correlation with the EUR/USD and a near perfect correlation with USD/JPY. In other words, since last Thursday, a rally in U.S. equities has coincided with a sell-off in the EUR/USD and a rally in USD/JPY.  However this is a new development because over the entire month, the correlation between stocks and currencies has been very weak.  If we take a step back and look at the correlation between currencies and equities over the past 6 months, we can see that previously, the EUR/USD rose alongside equities.  It remains to be seen whether this new correlation can hold and if it does, it would break a relationship that has lasted for most of the year.   

Economic Data Preview and Review

Meanwhile the stronger existing home sales report completely offset the market’s reaction to the disappointing GDP report.  After last month’s solid number, many people believed that the pace of improvement in the housing market would slow and even though it did, the 7.4 percent growth was extremely impressive. The number of units sold in the month of November hit 6.54 million, the highest since Feb 2007.  This suggests that we could see similar strength in tomorrow’s new home sales report.  Personal income, personal spending and revisions to the December University of Michigan consumer sentiment report are due for release tomorrow.  Stronger numbers are expected all around.  As for growth, the third release of GDP revealed that the U.S. economy expanded by only 2.2 percent in the third quarter, a far cry from the initial estimate of 3.5 percent. The details of the report pointed to weaker growth in personal consumption, gross private investment and government consumption. Personal consumption was revised from 2.9 to 2.8 percent while PCE was revised from 0.5 to 0.4 percent.  

EUR/USD: CLOSING IN ON SUPPORT

It has been a bad month for anyone long euros.  The currency has been on a one way downtrend with virtually no recovery.  However, relief may be in sight with the EUR/USD closing in on a very important support level.  The 1.4185/90 level represents the September low as well as the 200-day SMA and the second standard deviation Bollinger Band.  Part of the reason why the Eurozone has not rebounded is because economic data has been light and the reports that we have been released did not help the euro.  For example, German consumer confidence for January fell from 3.6 to 3.3.  This week is a very quiet week in the Eurozone with no meaningful economic reports.  The only economic releases on the calendar tomorrow are German import prices and French consumer spending.  Meanwhile, the rebound in EUR/CHF has been far from impressive.  Having hit a high of 1.4989 intraday, the currency pair is ending the NY session closer to its low.  Thanks to the prior stabilization of the Swiss Franc, exports increased 1.6 percent in the month of November.  However along with a 0.6 percent rise in imports, the trade surplus actually fell from 2.44B to 2.14B.  

GBP/USD: UK ECONOMY REMAINS IN RECESSION

The British pound continued to weaken against the U.S. dollar, breaking its 1.60 support level in the process.  Although GDP growth was revised upwards from -0.3 to -0.2 percent, the positive sentiment from the report was offset by the reality that the U.K. was the only major country that failed to grow in the third quarter.  To the disappointment of policymakers, the country remains mired in recession. Unfortunately based solely upon the October trade numbers and the fourth quarter retail sales reports that we have seen so far, growth may have remained negative in Q4.  The outlook for growth is a critical component of the Bank of England’s monetary policy decisions.  Tomorrow, we will receive the minutes from this month’s central bank meeting which will indicate how many members favored keeping the Quantitative Easing Program unchanged.  If the vote was relatively tight with a good number of monetary policy members voting for additional easing, the pound could come under further selling pressure.  However if the vote was unanimous or if the tone of the minutes is slightly hawkish, the pound could easily rise back about 1.60.  Aside from the GDP numbers, the current account balance was also released this morning with the deficit expanding marginally in the third quarter.  

NZD/USD: GDP MISSES

Broad dollar weakness has pushed the Australian and New Zealand dollars lower but the Canadian dollar continued to buck the trend, rising for the third trading day in a row.  Disappointments in both Australian and New Zealand economic data contributed to the underperformance of the Asian currencies. The New Zealand economy expanded by 0.2 percent in the fourth quarter, falling short of the market's 0.4 percent forecast. For Australia, the Conference Board Leading index turned negative in October, signaling that the recovery in the Australian economy may be slowing.  There was no economic data released from Canada but the rise in crude prices and the prospect of stronger GDP numbers tomorrow is helping to lift the CAD.  The latest retail sales report indicates that consumer spending remains strong while the trade balance returned to surplus in October.  According to Canadian Finance Minister Flaherty, there are no signs of a housing bubble at this time but if a bubble were to develop, he can tighten standards and make mortgages tougher to obtain.  

USD/JPY: SIX DAYS OF PERSISTENT STRENGTH

For the sixth trading day in row, the U.S. dollar appreciated against the Japanese Yen, hitting a one month high in the process.  In fact, the strength of the currency pair has pulled all of the other Japanese Yen crosses higher.  Don’t forget that the reason why currency pairs such as the AUD/JPY are known as crosses is because their rate is dependent upon the value of USD/JPY and the AUD/USD.  Japanese economic data also disappointed, which may have added pressure on the Yen.  The latest report indicates that supermarket sales have been negative for12 months in a row while small business confidence dropped for the third consecutive month.  Unlike large businesses, small companies have not benefitted from the global recovery.  The divergence between the Tankan survey which measures the confidence of large businesses and Shoko Chukin report which surveys small businesses reflect Japan’s fundamental problems which is that stronger profitability in the corporate is not filtering into the rest of the economy.  According to a Reuters poll, the sentiment amongst Japanese consumers has also fallen for the fourth consecutive month.  There are no economic reports due from Japan tomorrow. The latest comment from Bank of Japan Governor Shirakawa that policy guided by short term price moves would destabilize the economy suggests that they have no plans to change monetary policy in term and economic fundamentals certainly support that.  

USD/CAD: Currency in Play for Next 24 Hours

he currency in play for the upcoming next hours is USD/CAD.  Canadian Monthly GDP data is on tap for tomorrow at 13:30GMT or 8:30AM EST. At the same time, the U.S. will announce Core PCE as well as Personal Spending and Personal income numbers. Shortly thereafter, the U. of Michigan Consumer Confidence and New Home Sales reports will be released at 15:00GMT or 10:00AM EST. Over the past 3 months, USD/CAD has been trapped in a range. The currency pair currently roams within the Range Trading Zone which we determine using Bollinger bands. A lack of trend and decrease in volatility has created an asymmetrical triangle that signals that a breakout is imminent. The upper boundary of the triangle acts as the key resistance level, particularly since it coincides with the 100-day SMA at 1.0680. Meanwhile support lingers at the 1st Standard Deviation which coincides with the bottom boundary of the same formation and the psychologically important 1.05 level.   

The information, including Commentary and Trade Ideas, provided on FX360.com should not be relied upon as a substitute for extensive independent research which should be performed before making your investment decisions. Global Forex Trading and FX360 .com is merely providing this information for your general information. The information and opinions presented do not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision and should tailor the trade size and leverage of their trading to their personal risk appetite. Any projections or views of the market provided by FX360.com may not prove to be accurate.

The views of the authors and analysts are not necessarily those of Global Forex Trading, its owners, officers, agents or other employees. FX360.com and the currency research team will not be responsible for any losses incurred on investments made by readers and clients as a result of any information contained on FX360.com. Global Forex Trading and the currency research team do not render investment, legal, accounting, tax, or other professional advice. If investment, legal, tax, or other expert assistance is required, the services of a competent professional should be sought.

• Share this:

Comments (4)

margaret

December 22, 2009 at 05:25 PM ET

Do you think the strength of the USD could make the AUD will drop to .8550 this year?

klien

December 22, 2009 at 06:13 PM ET

hard to say. there are only a handful of trading days left this year but it def looks like dollar bulls remain in control

schultzz.at

December 23, 2009 at 07:47 AM ET

The U.S. GDP report was a huge disappointment. Contrary to the second estimate Fixed Investment was again a drag subtracting 0.15 percentage points. Fixed Investment has not shown a positive contribution since Q2/07. But at least Residential Investment contributed +0.43, its first positive contribution since Q4/05. Personal Consumption (+1.96), the slowdown in Inventory Liquidation (+0.69) and Government Consumption (+0.55) ensured growth. The widening trade deficit is again hurting the economy (-0.81).
The report concludes the summer quarter. In the current quarter we see solid personal consumption and inventories are no longer falling. So the main growth contributors for Q4/09 could remain the same.
Meanwhile risk traders are celebrating their Santa Rally with the S&P and Nasdaq 100 at new highs for the year and the spread between 2-yr and 10-yr Treasury notes at a record 2.85 percentage points.
Former Fed chairman Alan Greenspan said in November that the gain in stocks is 're-liquifying' the U.S. economy. I am wondering how this works as long as investors are reluctant to exchange their stocks for cash.
In the mean time the USD has completed some impressive bottom formations against other currencies. Crude oil and gold bulls also had to cope with some defeats recently.
The whole environment seems to develop into a Catch-22 situation for USD bears. If economic numbers, especially non farm payrolls, keep coming in strong in January 'interest rate hike expectations' will support the currency. Otherwise USD bulls could show the 'risk aversion' trump card.

oboe234

December 23, 2009 at 08:51 AM ET

Three scenarios 1. The dollar /stock market/oil paradigm is dead, 2. The stock market and oil are correct and the dollar is going to fall dramatically, 3. The stock market and oil are having a sunny day and they are going to fall dramatically. Make your wager on where the ball lands as the roulette wheel spins.

Is the flight out of dollars into anything else continuing? Has the threat of inflation or even hyper inflation abated due to some new policy statement? Has the US congress decided to tighten the belt or has Ben of the fed had a religious experience and is going to reverse over a decade of constant dollar devaluation? Is the rise of the dollar a means to reinvigorate the validity of all fiat currencies?

You can boil a frog alive if you turn up the heat slowly and the frog will not notice. Is the dollar slowly being devalued into oblivion at a slow pace in the hope the world will be able to decouple and trade will continue minus the US?

The last question is Afghanistan. Is it not amazing that the dollar rise started when President Obama decided to stay in. Why is he committing political suicide? Is there a deal to support the dollar for continuing the war / wars? I remember last year when Bush committed the government to full support of the debt of Frannie and Freddie. The dollar shot up.

I do not believe that the 11 year trend of dollar devaluation will stop. If a ship is sinking you can raise the ship up or lower the ocean down. I think that Ben of the fed is working as hard as he can to lower the value of the dollar to sustain asset prices. I went totally into dollars at just the right time by pure pure luck. I am now looking to get out of dollars and trying to pick a time. Good fortune to all and party out the old year, it has been interesting.

Add Your Comment

Please login to post a comment or sign up for an FX360® account.

Loading...

About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.