Equities are up, the dollar is down and no one can agree on whether currencies are driving equities or vice versa. If you ask a currency trader, they will most likely say that the reason why the dollar sold off today is because equities are higher. However if you ask an equity trader why stocks are up chances are that they will say that it is because the dollar is down. In reality, there is no easy answer, just like the question about what came first, the chicken or the egg. Currency markets operate 24 hours a day and to some degree, equities do so as well on Globex. This means that even before the U.S. equity markets officially open, traders are already expressing their views through futures. In general, the relationship between equities and currencies is much more symbiotic which means that sometimes it is stocks that are driving currencies and vice versa. In the case of the past 24 hours, an intraday chart of the EUR/USD and S&P 500 reveals that currencies are leading equities and not the reverse.
Correlation between Currencies and Equities
In the following 5 minute chart of the EUR/USD and the S&P 500, we have circled two big intraday moves. In the first, the S&P 500 started to turn before the EUR/USD but the move in stocks only gained traction after the big breakout in the EUR/USD. In the second area that is circled, the rally in the EUR/USD (blue line) peaked before the rally in stocks (green line). However a closer look at the chart should also indicate that there are occasions where the S&P 500 makes a move before the EUR/USD. Taking a step back, the correlation between has been strong throughout the year. On a 12 month basis, the EUR/USD has had an 86 percent positive correlation with the S&P 500. Over the past 6 months, this correlation has increased to 94 percent. Yet the correlation has not always been this strong. For example, in 2007 the EUR/USD appreciated gradually throughout the year from 1.30 to 1.47. During that same time, there was a significant amount of volatility in the S&P 500 even though the index ended the year virtually unchanged. The correlation between the dollar and equities will break when the dollar finally moves on U.S. fundamentals, meaning that good data becomes positive for the greenback. This will most likely occur when the U.S. stages a full blown recovery that eclipses that of its peers.
All Eyes on Housing
The housing market is a big focus this week. This morning's existing home sales report was exceptionally strong with the number of units sold rising by the most since Feb 2007. The demand was partially driven by tax incentives which were originally set to expire on November 30th and has now been extended to April 30th. The 10.1 percent rise is glaring evidence that despite a drop in builder confidence, permits and housing starts, the market for previously owned homes remains hot. The only wrinkle is that units are still being sold at lower prices but that is expected given the current state of the economy and tightness of credit. The average price of a home sold dropped from $221.9k to $218.1k in October. A variety of house price reports are due for release tomorrow along with the second release of third quarter GDP, consumer confidence and the minutes from the most recent FOMC meeting. Q3 GDP is expected to be revised downward given the downward revision to retail sales and trade numbers. As for the Fed, their recent tone has been cautious and pessimistic. Unfortunately we expect this sentiment to be echoed in the minutes. Last week, Bullard suggested that the Fed may not raise interest rates until 2012 and overnight, he called on the Fed to extend its authority to buy Mortgage Backed Securities and Agency bonds beyond March. Although this represents a departure from his typically more hawkish stance, it is important to remember that Bullard is a non-voting member of the FOMC. Yet, there is no question that most FOMC members are still very cautious. Evans for example warned that the unemployment rate may not peak until 10.5 percent and not decline until the summer. The more cautious the Fed is, the less likely they are to implement an exit strategy and the more likely the dollar carry trade will remain intact.
EUR/USD: ANOTHER STAB AT 1.50?
The EUR/USD took another stab at 1.50 today and unfortunately failed to break above the key level. We have been asked repeatedly why the 1.50 is so important and the reason is because traders are humans and humans like to think in round numbers. There are a ton of option barriers and stop orders sitting above 1.50 and there is clearly a strong desire to defend against a break of that level. However economic data is on the side of euro bulls. Eurozone PMI reports were surprisingly strong with both the service and manufacturing sector PMI numbers edging higher. The German IFO report is due for release tomorrow and even though there have been improvements in manufacturing sector activity, factory orders grew at a slower pace last month while the ZEW survey declined. This suggests that we may only see a limited pickup in business confidence. In addition to the IFO, the final Q3 GDP numbers are also scheduled for release from Germany. Meanwhile the market barely reacted to ECB President Trichet’s comment that a strong dollar is good for the international community because there was nothing new in his comments. At this point, he would need to use far more critical words to turn the euro around. We continue to believe that the 1.50 level will only be a temporary barrier in the EUR/USD and that the U.S. dollar could fall another 5 to 7 percent before it stages a full blow recovery.
USD/JPY: DOWN ACROSS THE BOARD
The yen was weaker across the board with USD/JPY posting slight gains. However, the big moves were reserved for the yen crosses and pairs like NZD/JPY and AUD/JPY which surged about 1.5% and 1.25%, respectively in today’s trading alone. Nevertheless, when looking at the big picture, the yen has yet to surrender any substantial portion of its move against the dollar, even as the VIX plummets more than 5.0%. Obviously, the once significant relationship between the movement in the yen and volatility index have broken down substantially, with the correlation over the last 12-months sinking to only 20.6%. Today’s trading has been riding on a sheer lack of economic data due to Japan’s Labor Thanksgiving Day. Things will pick up a little bit tomorrow with the Bank of Japan Monthly report. Since the BoJ has officially admitted that deflation is taking hold, it remains to be seen how exactly the bank plans to respond. The BoJ is definitely in a bad position as its considerations to start exiting unconventional policies may have to be delayed as to keep deflation at a manageable level. Scheduled for tomorrow night with be the Merchandise Trade Balance which is always important because of the implications it has on how the yen is affecting trade.
EUR/USD: Currency in Play for Next 24 Hours
EUR/USD will be the currency pair in play for tomorrow. The Euro-zone will release the German Gross Domestic Product at 2:00 am ET or 7:00 GMT followed by the IFO survey at 4:00 am ET or 9:00 GMT. US trading will be even busier with the Gross Domestic Product and Personal Consumption reports due at 8:30 am ET or 13:30 GMT, Consumer Confidence at 10:00 am ET or 15:00 GMT, followed by the FOMC Minutes at 2:00 pm ET or 19:00 GMT.
Even though EUR/USD managed to rise back into the Bollinger band buy zone, the pair continues to struggle within a very tight contractionary zone. In the past few weeks, the pair has rarely exceeded a 200 pip zone capped by the important 1.4800 and 1.5000 levels. However, if today’s gains manage to spur a new rally, resistance is strongest at the 1.5060 level which was the October 23rd high. If the pair should falter once again, the 1.4800 level should stand in as support as it has been tested several times in providing the lower bound for the trading range and was the low for November 20th. Nevertheless, momentum has not been convincing in either direction which may result in a continuation of directionless trading.
May The Force Be With You.
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