By Stephen L. Bernard, DJ FX Trader
Analysts and strategists started using a pet phrase ad infinitum during the past few weeks of volatile market movement: Equities are moving with currencies. Particularly, the Dow Jones Industrial Average is moving with the euro-dollar exchange rate.
Turns out that’s not really true.
A close look at movement between the Dow and euro-dollar trading shows there’s no discernable, consistent connection between the pair. The 10-day and 30-day average correlations between the two over the past week max out at 0.23 and 0.49, respectively, according to data from CQG. That’s on a scale where 1.00 means a perfect direct correlation and -1.00 means a perfect indirect correlation.
There doesn’t seem to be a grand explanation for why so many market observers were so wrong. It comes down to the fact that “too many people try to sort of explain away the minutiae of every single move, every single day,” said David Renta, senior vice president for institutional foreign exchange at KeyBank. Sometimes the market just moves without logical explanation.
To be sure, some correlations are still quite strong even during market craziness. The 10-day correlation between the dollar-Swiss franc exchange rate and the Dow, for instance, hasn’t dropped below .62 this month–that’s because when people buy the safe-haven franc, they’re typically not feeling risky enough to buy stocks.
That said, other analysts–the ones who didn’t jump to the correlation conclusion–say assets are often driven by nuanced factors during times of global economic panic, so it’s difficult to measure specific connections.
When this happens, analysts and media fall back to old explanations and routines. The 30-day average correlation between the euro-dollar exchange rate and the Dow has, in fact, spent almost three months above .80–between August and October last year. It’s also spent bouts of time at those high levels through the first half of the year. Correlations rarely hold for long stretches without occasional breakdowns.
Historically, the relation between stocks and the euro is strong when benchmark interest-rate differentials and expectations for future monetary policy favor the euro zone, signaling strong risk appetite, says Rebecca Patterson, chief markets strategist at J.P. Morgan Asset Management. Risk appetite has been mixed in the past few weeks because of worries about a global economic slowdown.
The 30-day correlation between the euro-dollar exchange rate and the Dow was 0.20 on Monday. The 10-day correlation was 0.27.
Oliver Pursche, president of Gary Goldberg Financial Services, says major equities indices are moving higher and lower based on stock traders’ thoughts on whether the world will fall back into another recession, not because they’re tracking them alongside currency pairs. He says the euro is primarily susceptible to concern over the regions ongoing sovereign debt problems.
He says market participants’ never-ending search for ways to explain asset movement means sometimes their imaginations get the best of them. “People always look for correlations.”