The following is our monthly correlations update for April. 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. As investor confidence has slowly recovered, we have seen that the focus on yield has also exposed the belief that many of the commodity producing economies also seem to be the most stable. In turn, we have seen this lead to a broad demand for these ‘com bloc’ currencies. In turn, we have seen the correlation between the front valued AUDUSD and NZDUSD tighten (0.87) as traders abandon the liquidty-backed dollar safe haven in favor of a couple of the highest yielding G10 currencies. The same fundamentals are behind the AUDUSD and USDCAD’s strong relationship (-0.92); but the reversed place of the base currency makes for a negative correlation rather than a positive one. 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 wax and wane depending on the time frame. Over the past six months, the correlation between AUDUSD and USDJPY was relatively strong (0.54). At first this would seem unusual considering the dollar and is the base currency for one pair and the counter for the other. However, this has to do more with the changing nature of risk appetite and the market’s considerations for which currencies are actually considered safe haven currencies. When investors the world over are looking to avoid unstable markets, they have gone invariably to either the dollar or the yen (the top safe haven has been debated by the market). Recently though, with investors starting to slowly accept risk into their portfolios, we have seen the relationship between the two currencies diminish and the correlation fade (0.04). 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 04/01/09)
