Forex Correlations

I thought I would write a piece on correlations and how we can apply them to our trading. Understanding how markets interconnect and the way they correlate is probably the most important piece of the market jigsaw, keep in mind when reading this post that correlations can and do change overtime, so what you see in front of you today may not be how it is in the future.

• USD/US Treasury Bonds - When the US bond yield moves up so does the US dollar. This is correlated because as the USD becomes stronger, then demand for US Bonds becomes stronger as well. US Treasury bonds are also sought after cause the USD is the worlds reserve currency so hence any bond issued by the treasury is seen as very safe.
• Gold/AUD/CAD/NOK - Gold is a safe haven play in the market but is also correlated heavily to the commodity currencies like the aussie and the canadian. As the demand for gold goes up so does the commodity currencies demand as the major they are the major gold producers.
• USD/Gold - have an inverse correlation as the demand for gold goes up so does the supply of USD, meaning that USD will be sold and gold will be bought, no better evidence of this than during the first 11 months of 2009. Gold is also seen as a safe haven play as noted during the past year. A recent phenomenum in gold is the awesome demand that the emerging world puts on the remaing gold supplies, if this contines the spot gold price will also continue to rise.
• Crude Oil/ USD/US Treasury Bonds - if the price of crude goes up then the price of USD goes down as does the price of US Bonds, oil is pegged to the price of USD, one goes up and one goes down and vice versa its that simple.

Most of the currency pairs are correlated to each other in one way or another, such as USD pairs often will move somewhat together. Whilst I dont want to list all of them as some have more significance than others. I will list a couple I use as strong evidence.

• EURUSD/USDJPY - If the eurusd is moving up then the usdjpy is moving down, they have an inverse relationship to each other. This correlation can also be linked to US Bond yields the lower the yield the more that USDJPY will be sold and vice versa.
• EURUSD/USDCHF - This is the same as the above, in that they too have for the most part an inverse relationship to each other, as one goes down then the other goes up.

In post Gloabl financial Crisis times, some interesting correlations have emerged.

• In the US the more the Federal Reserve maintains a loose monetary policy with record low interest rates, the more unattractive the USD will become and the sell off will remain in place.
• In Japan whilst a deflation environment remains a real threat, then the Bank of Japan will keep an incredibly loose monetary policy with next to zero interest rates meaning the yen will get cheaper as its reinforced as one side of the carry trade.
• In Australia as Interest rates are raised to keep a lid on inflation, then the difference between the Aussie dollar and other currencies will widen making the Aussie dollar more atrractive and it will keep its bid tone.

Correlations are everywhere, use them as supporting evidence for your trades and give them the highest probability of success.