The following is our monthly correlations update for September. 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 EURUSD and GBPUSD is different than having a portfolio comprised of EURUSD and USDCHF. As indicated in the tables below, the preoccupation with the dollar and interest rate forecasts has lead strong correlation (0.88) between EURUSD and GBPUSD. On the other hand, with the economies of Euro Zone and Switzerland so integrated, the EURUSD and USDCHF correlation (-0.86) easily stands on the other side of the spectrum. This means that having long exposure in both EURUSD and long USDCHF would generally negate profit or loss because when EURUSD rallies, USDCHF 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. Alternatively, holding long EURUSD and GBPUSD 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 that correlations shift with time. In the past few weeks, the focus on risk sentiment has dramatically increased the correlation between those pairs that have a carry interest. Over the past 6 months, when carry had drifted for most of the period, there was absolutely no correlation between AUDUSD and USDJPY (0.00). However, as the financail crisis reared, that connection quickly changed (0.50). Shifts such as these occur often and can be partially explained by changes in the severity of monetary policy or changes in market conditions. 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 10/01/08)