In the past three months there has been a clear and so far inexhaustible rally in risk appetite. While this has broadly pummeled the US dollar, it has also encouraged a jump in demand for those currencies backed by commodities and high yields.
The following is our monthly correlations update for June. As we have stated time and again, correlations between different currency pairs will inevitably shift over time. Therefore, it is of utmost importance to keep abreast of these fluctuating relationships to fully understand your trades and portfolio. 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 AUDUSD and NZDUSD is different than having a portfolio comprised of AUDUSD and USDCAD. In the past three months there has been a clear and so far inexhaustible rally in risk appetite. While this has broadly pummeled the US dollar, it has also encouraged a jump in demand for those currencies backed by commodities and high yields. Whether or not this is a confirmed sign that risk appetite has turned positive for good or not is debatable. However, the clear shift in sentiment has nonetheless had its direct impact on correlations among the majors. Between the two highest yielding currencies among the G8, we have seen demand push the positive correlation between AUDUSD and NZDUSD to impressive levels (0.94) through the past month. Flipping the base currency, AUDUSD and USDCAD maintain the non-greenback link (-0.81), but it should be noted that particular discretion in yield has tempered the monthly correlation since last month (-0.86). From a trading perspective, this means that having long exposure in both AUDUSD and USDCAD would offset much of the profit or loss that could be derived by holding a single position because when AUDUSD rallies, USDCAD 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. In contrast, holding long AUDUSD and NZDUSD 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 correlations rise and fall through different periods. As the waves of risk appetite have built over recent months, we have seen pairs that are otherwise unrelated take up a similar cause. For USDCHF and USDCAD, just six months ago, the growth and interest rate considerations between the two pair offer a weak link in price action (0.38). However, as the demand for yield grew and unwinding of the safe haven US dollar hit a new gear, the correlation between the two surged to its highest level in months (0.81). 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 06/01/09)
[I]Written by: John Kicklighter, Currency Strategist for DailyFX.com
Questions? Comments? Send them to John ([email protected]) [/I]