Shift in the correlation between currencies and stocks

The chart on the left shows the 40-day correlation between the GBP and the FTSE100. For the past two years the correlation has been persistently negative, at times exceeding -50%. With such a correlation a 1% fall in GBP should translate into a 0,5% rise in the FTSE100 index. The economic logic is that a weaker pound means more competitive exports and thus income for large exporters. This correlation, however, shifts to positive in the past few months: in the lower panel you can see the correlation turned positive around June-July this year

This can also be seen in the correlation between EUR and Stoxx50:

Here we can see three episodes of positive correlation, with the current positive correlation being higher than previous episodes.

The combination of a strong dollar and risks to the global economy are most likely suppressing risk appetite for instruments like the euro and European stocks. This can be seen from a simple observation of the chart of EUR/Stoxx50: periods of strong correlation are periods of sell-offs; in other words, positive correlations in these markets means that the markets are in periods of stress and risk-off mood.

This can also be seen from the correlation of USD/JPY and the Nikkei225 index:

We don’t think that the present positive levels of correlation can be used for systematic profiting in the markets, because of the risk that the correlation can break apart at any moment and cause serious losses.

It can, however, be used as a barometer of market sentiment. In calm times the currencies of exporters and their respective stock indices should be negatively correlated. The present positive levels indicate a risk-off mood in the markets. We believe that the correlation between the currency and the stock index should be tracked to see if markets are in a calmer or in a more tense mood.

Source: Bloomberg Finance L.P.

Chart: Used with permission of Bloomberg Finance L.P.

 Trader Velizar Mitov

Read more:
If you think, we can improve that section,
please comment. Your oppinion is imortant for us.
WARNING: Any news, opinions, research, data or other information contained within this website is provided as general market commentary and does not constitute investment or trading advice. Varchev Finance Ltd. expressly disclaims any liability for any lost principal or profits which may arise directly or indirectly from the use of or reliance on such information. Varchev Finance Ltd. may provide information, quotes, references and links to or from other sites and blogs and other sources of economic and market information as an educational service to its clients and prospects and does not endorse the opinions or recommendations of the sites, blogs or other sources of information.
Varchev Finance