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Standard Chartered’s Priyanka Kishor has spotted an interesting new development in correlations.
As has been well documented, since the 2008 crisis, ‘risk off‘ market temperament has strongly coincided with dollar inflows. In short, ‘risk-off’ has equalled ‘dollar positive’.
But since the end of 2011, things have been changing.
From Monday’s FX alert (our emphasis):
A cornerstone of the FX markets since the onset of the global financial crisis has been the negative correlation between the USD and US data surprises "“ i.e., the USD has gained on weak data and in risk-off environments. This has led to the riskon/risk-off trade, whereby all risky assets have gained or lost in tandem on risk positive or risk-negative developments, regardless of their own fundamentals.
However, this pattern has not held of late. Since Q4-2011, the 12-month rolling correlation between the USD and Citigroup"?s US economic surprise index has turned positive (see Chart 1).
At the same time, the 12-month rolling correlation between the S&P 500 and EUR-USD has tumbled to 0.30 from a high of 0.81 on 19 May 2011.
What explains this shift in USD behaviour? Firstly, the USD’s pro-cyclical behaviour has coincided with strong US data . This has reduced investor expectations of QE3 in the near future and has supported the greenback. Secondly, liquidity injections by other central banks, including the Bank of England (BoE), the Bank of Japan (BoJ) and the European Central Bank (ECB), have prompted investors to diversify away from the USD as their preferred funding currency.
So where has the risk-off trade been heading instead? Seemingly most Asia-ex Japan and commodity currencies like the AUD.
With that in mind, SocGen’s Sebastian Galy observes the following regarding AUD on Monday:
With profit taking on the cards, investors are looking to put on tactical bearish trades. With such a strong rally in AUD and correlation with equities, the temptation is to put on AUD bearish positions vs USD and EUR. AUD vols remain relatively low and we have seen a move to negative watch of major Australian banks given their USD funding (see Chart 1 of foreign bond issuance in Asia).
Related links: Alternatives to the USAAA, dollar edition – FT Alphaville Risk off, with nowhere to go - FT Alphaville The great Australian bond run – FT Alphaville
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