The Inevitable Breakdown of Currency Correlations
During the Global Credit Crisis of 2008, investor focus was on risk aversion. Investors were scared, so a tight correlation between U.S. equity markets and the U.S. Dollar began to form. As equity markets sold off, the U.S. Dollar entered into one of its most rapid periods of strength in history. And then, as markets rebounded sharply in March of 2009, we saw the U.S. Dollar begin to rapidly depreciate. In late 2009 and early 2010 as rumors of a possible sovereign default in Greece began to grab the headlines, the U.S. Dollar again gained incredible momentum as investors sought to park their assets in a safe place.
Thus, for the last two years, as a rule of thumb, when U.S. news has come out good, we have seen a sell-off of the U.S. Dollar as investors gain confidence and seek higher yield in risky investments and higher yielding currencies. Currently, we are seeing the beginning stages of this correlation begin to break down. Thursday July 1st was a massive day of U.S. Dollar weakness in the FX Market as we saw the Euro rally over 350 pips on the day and the British Pound rally over 340 pips. What’s so interesting about this move is that global equity markets have sold off sharply this week, and so has the U.S. Dollar index. Seeing the Euro and the Pound post new HI’s and break through rather significant levels of resistance in very active forex trading, while equity markets are taking a pounding is not what we have seen over the last two years. Why is this happening?
The Dow Jones Industrial Average formed a low in March of 2009 at 6,500, and then began a sharp rally over the next 9 months to finish out the year. During that time, the U.S. Dollar lost significant value as investors became assured the worst of the recession was behind us. Cataclysmic failure of the global financial system had been avoided and it was time to get out of the safe, but very low yielding dollar and get to work producing high returns in order to make up for what ended up being a rather disastrous year in 2008. During this time, it looked as though Europe was going to emerge from the recession faster and stronger than the U.S, which meant they would be first to raise interest rates. Look through the benefits of fx trading for more information on this.
And then Greece happened. Investors once again retreated to the safety of the U.S. Dollar as the Euro reached multi-year lows in a matter of months. But now we are seeing some very interesting action. The EuroZone has stabilized at the moment due in large part to the bailout package created for struggling countries, so there is not as much concern of sovereign default, and the U.S. who was seemingly heading the return to economic growth over the last 6-8 months is now hitting some major roadblocks. Growth is proving to be very sluggish and unemployment is remaining at uncomfortably high levels.
This is leading investors to begin shirking the U.S. Dollar as it now appears England and Europe will both hike interest rates before the U.S., who in classic Keynesian style, continue to boldly proclaim they will be keeping interest rates low for an extended period of time. So, as U.S. news comes out bad and equity markets take a hit, investors are not running into the U.S. Dollar over these last few days, but are instead running away from it as it becomes more certain the U.S. will be lagging behind in a return to normal interest rates, which will produce an even further widening of the interest rate spread between the Dollar versus the Euro and Pound.
