Self learning forex is easy :)
I have often spoken about the inverse correlation of equities and the US Dollar for sometime now and i frequently use the state of the equities worldwide as a clue for medium to long term currency movements.
While the inverse correlation is there, it is rather loose and hence i do not find it suitable as a tool for short term speculation. ( My daily reviews of the EUR/USD on the other hand focuses on the S&P 500, an US equities index and hence perhaps providing a slightly tighter inverse correlation for intra day clues )
Find below 2 charts. The MSCI World Index ( Index consisting of a collection of developed markets equities) is on the top while the US Dollar Index ( Index consisting of a collection of currencies versus the US Dollar ) is at the bottom.
Source: Bloomberg
In the first section, it is pretty interesting. Both the equities and US Dollar indexes are falling. This seems to suggest that while the general equities markets have already begin to experience the troubles of the subprime crisis, the currencies folks are pretty much oblivious to the problem ( perhaps new investors or extreme risk seekers ) and are seemingly still selling their US Dollars for foreign currencies as a means of foreign investment.
In the middle section, the subprime crisis and later the credit crunch have hit full blown proportions. Lehman Brothers falls into this timezone. Here we can clearly see the inverse correlation forming as the MSCI World Index fell due to the drop in equities prices worldwide while the US Dollar Index strengthen due to the flight to "safe" assets. Note that the US Dollar Index had a totally unexpected spike towards the end of 2008? This suggests that currencies are indeed more volatile compared to equities and hence my term "loose" inverse correlation and my reluctance to use this inverse correlation as a clue to short term forex positions. The turning points of both indexes in early 2009 ( circled ) reaffirms me that an inverse correlation seems to have developed for now.
In the last section which is till date, the MSCI World Index climbs as the economy "recovers". In a inversely correlated fashion the US Dollar Index drops, probably due to the selling of US Dollars for investments and higher yields elsewhere in the world ( My US Dollar article here talks about the record low interest rate in the US )
Folks before you go rushing off to scan and match the movements of both indexes, do keep in mind that correlations or inverse correlations do not last forever and hence there is no easy way out in forex!
Do you homework always and monitor for the continuation or divergence of the inverse correlation.
Trade safe.
