Euro/US Dollar Very Strongly Correlated to Dow Jones Industrials - Why?

Written by David Rodriguez, Quantitative Analyst

The forex market has recently regained its strong correlations to global stock markets, as strong risk-linked flows hold substantial influence over short-term direction in the Euro, US Dollar, and Japanese Yen. Such developments are a stark change from just several weeks ago, when forex traders seemed increasingly indifferent to moves in the US Dow Jones Industrials Average and other key risk barometers.

At the end of the day, it seems that the fate of the Euro/US Dollar may almost completely depend on the trajectory of equity markets. Given overwhelmingly bearish medium term momentum in global stock indices, this would arguably leave a bearish bias on the EUR/USD and similarly risk-linked USD/JPY. All the same, the US Dollar has become increasingly independent of commodity prices. Assets such as gold and oil are typically seen as a hedge to inflation and dollar weakness, but that has seemingly not been the case as of late.

Forex Correlations Summary

Forex correlations against Oil, Gold, and the Dow Jones Industrials Average for the past 30 calendar days:

Strongest Forex Correlations

Euro/US Dollar and the US Dow Jones Industrials Average The Euro/US Dollar has held a near record-high correlation to the US Dow Jones Industrials Average, emphasizing that both currencies are increasingly linked to global risk trends. This implies that the US Dollar may continue to benefit from financial deleveraging flows—an ostensibly bullish proposition. On the other side of the coin, the euro has increasingly been punished by flare-ups in financial and geopolitical tensions. Threats to Euro Zone stability arguably explain part of this dynamic. Further tensions and sovereign debt downgrades to EMU members could force EUR losses.

Canadian Dollar and the Reuters CRB Commodity Price Index The US Dollar has largely lost its correlation with oil and other key commodity prices, but the Canadian Dollar nonetheless remains sensitive to movements in crude costs. In fact, the 20-day correlation between the Canadian Dollar/US Dollar exchange rate now trades at its highest levels in at least 10 years—emphasizing the strength of the link. Conceptually, we might expect that lower prices would decrease crude oil’s influence on the CAD. Yet the near-opposite has been true, and it is seemingly important to keep tabs on crude oil when trading the USD/CAD.

Weakest Forex Correlations

Euro/US Dollar and Gold Futures Prices Gold has historically been used as a hedge against US Dollar weakness, but recent price action suggests that gold has lost its luster as a dollar hedge. In fact, COMEX Gold prices have moved inversely with the Euro/US Dollar pair—implying that gold is moving in the same direction as the US Dollar itself. Subsequent trading bias for both the EUR/USD and Gold is admittedly unclear, but it seems less relevant to monitor commodity costs as far as USD trading is concerned.

Euro/US Dollar and Crude Oil Futures Prices The highly-touted link between the US Dollar and Crude Oil prices has become virtually insignificant, as the US Dollar has moved largely independently of developments in commodity markets. Whether or not this is a temporary shift is up for debate, but we would argue that the sharp drop in crude oil costs decreases its real impact on the US Dollar exchange rate. Regardless of the reasons, it seems that crude oil is currently of very little significance to US dollar currency pairs.

Written by David Rodriguez, Quantitative Analyst for DailyFX.com
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