Recent sharp declines in the US S&P 500 and other financial market risk barometers have pushed cross-market correlations sky-high through recent trade. All leveraged markets have been moving much in the same direction through recent episodes of financial market distress—emphasizing the level of interconnectedness across key markets. A glaring example is the record-correlation between the FX Carry Trade and Gold prices. These two seemingly unrelated markets are both highly leveraged and have seen impressive gains through recent months. With a sharp episode of financial market deleveraging, they likewise fell in unison against the resurgent US Dollar. It will be critical to monitor any and all turmoil in financial markets and its effects on the US Dollar.
Forex Correlations Summary
Forex correlations against Oil, Gold, and the S&P 500 for the past 30 calendar days:
Strongest Forex Correlation
[B]FX Carry Trade and Gold Prices[/B]
The FX Carry Trade and Gold Prices have been moving in near-unison through the past 20 trading days at an impressive 0.94 correlation coefficient. The two seemingly-unrelated asset classes are linked due to their underlying exposure to the US Dollar. As the currency with the lowest overnight yields in the world, the US dollar is firmly on the "short" side of any carry trade portfolio. Given that gold prices are likewise quoted in US dollars, it is little wonder to see why they should be linked. Furthermore, pronounced financial market duress will tend to force many leveraged assets to move in the same direction.
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[B]S&P 500 and Reuters CRB Commodities Index[/B]
The US Dollar has likewise been very closely correlated with Commodity markets, and the near-record-strength short-term correlation between the S&P 500 and the Reuters CRB Commodities Index only emphasizes said fact. It is relatively obvious that Dollar-denominated commodity prices should move on Dollar weakness/strength, but beyond this link we likewise see that financial risk sentiment is at a point where substantial weakness in one market could spread to another quite quickly. Traders should be on the lookout for sharp moves in oil and precious metals especially. Again, correlation does not imply causation, but sharp moves in Oil could translate to similar moves in the Dollar. [IMG]http://forums.babypips.com/export/story-images/2009/10/currency/Trading_Signals/Forex_Correlations_2010-02-15_3.gif[/IMG]
Written by David Rodriguez, Quantitative Strategist for DailyFX.com
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