The following is our monthly correlations update for May. 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 five months, the markets have found what passes as an extended period of stability. While this is not necessarily the definitive sign of a recovery; it has led the deleveraging flows of the past two years to slow and encouraged reinvestment yield-bearing investments. In turn, we have seen the correlation between the high rate differentials from AUDUSD and NZDUSD cultivate a high, positive correlation (0.89) as traders moved out of the safe haven US dollar and into the deeply depressed commodity currencies. Similar fundamentals are behind the AUDUSD and USDCAD’s strong, negative relationship (-0.86) over the past month; but here we see the commodity factor coming more into play. From a trading perspective, this means that having long exposure in both AUDUSD and USDCAD would generally negate profit or loss 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. Over the past six months, the correlation between USDJPY and GBPUSD was relatively strong (0.53). This is largely due to the shift the influence of risk appetite on the general market. Both the US dollar and Japanese yen are considered safe haven currencies. Therefore, when there are is no extreme in sentiment, USDJPY is left to chop while GBPUSD continues to play out its far more sensitive relationship to the back and forth in optimism. Over the past month however, the relationship has recovered (0.53) as the slow recovery in risk appetite has led to an appreciation in those currencies considered to be income currencies. 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 05/01/09)
