In Price Action Trading Strategy

Many investors that try to decipher market flows and attempt to understand the way money moves in and out of this or other markets are likely to, at one point or another, refer to the correlation between equities and currencies.

I can tell you that before U.S. rates went into the dumper the USD/JPY correlation was one of the industry's standard “go-to” points in terms of monitoring future movements. At my former hedge fund, equity analysts were regularly peering into the relationship between EUR/JPY and equities in order to gauge any form of momentum as part of their daily routine.

When we talk about “risk exiting the market” aka risk aversion, what is the common notion? Equities decline, higher-yielding currencies do as well while your more traditional “safe haven” instruments (aka USD…and we use the term “safe haven” in the traditional sense) get the push.

But how stable is this, really?

In terms of this correlation, rates matter most. On the chart below I plotted the S&P 500, overlayed by AUD/USD (green), EUR/USD (yellow), EUR/JPY (white), USD/JPY (blue), and AUD/JPY (red). When USD/JPY went on its serious decline following the earthquakes I posted a chart comparing it to equities, showing the massive unraveling in terms of correlation since the beginning of talks about the Fed lowering at the end of the recession. Not until recently have we been showing any form of pickup in terms of this coming back together.

But through it all and in recent times, higher-yielding currencies have shows the sharpest relationship, where the differential between the country's benchmark rates versus their peers have maintained any form of balance with equities. In the chart below, you can see AUD/USD and AUD/JPY (rate differential currently ~ 4.60%) sharing the sharpest relation.

The others have been much more susceptible to differentiation or just flat out instability in terms of the correlation.

And this changes over the long term, without question, as we just discussed with USD/JPY.  These fluctuate and naturally if you are attempting to trade using any form of correlation analysis you simply need to be on you game in terms of when they shift.

The reason I am even writing about any of this today is thanks in part to a post by Marc Chandler of Brown Brothers Harriman yesterday, so when you're finished with the chart below please head over to the following link and continue reading for more info on this topic:  http://www.marctomarket.com/2011/05/currencies-and-equities.html

I wrote another brief article on this topic quite a while back, but more specifically in terms of bonds. You can find that post here: https://paracurve.com/2010/06/interest-rateequity-marketdollar.html

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Showing 6 comments
  • fxlol
    Reply

    Steve,what charts(platform) you use?
    Thanks.

    • Steve W.
      Reply

      Hi – this is just a screenshot from freestockcharts.com … quick and easy.

  • Steve W.
    Reply

    Opinions…..gotta love them. It’s all personal Ross. That was before the 2008 collapse when JPY was the rate lagger vs. others.

  • Chris
    Reply

    Hi, Steve. Is it only that currencies lead equties or does it work the opposite way also?
    And do you use it for intraday analysis?

    • fxlol
      Reply

      Maybe i wrong,but on my opinion not currencies lead equities or versa. I think there lead risk sentiment : appetite(positive) or aversion(negative). If we have better than expectations news, geo-political stability, rumors and rhetoric speech about rise interest rate – traders take more risk : up higher-yielding assets(such as AUD,NZD),commodities, equities and lower safety:bonds, JPY, CHF and less USD. And opposite way.
      But, maybe i wrong, wait Steve reply.
      (Sorry for my bad English)

      • Steve W.
        Reply

        I would agree with you……what might lead one day might not the next, and so-on. A rookie assumption is that one is simply going to dictate the other, but this, like the relationship discussed above, can be erratic. When you group everything together and look and look at cross-market flows you can observe them on a collective basis, but ultimately they are all individually driven by traders reacting to rhetoric and actions. Any correlations that exist are a reflection of this collective sentiment.

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