Forex and Intermarket Correlations Part 2

It's been several days since I had a chance to post due to the July 4th Holiday (which was a great one here) so I'm glad to be back to the blog.

Today we want to consider a bit further market correlations and the forex, following up on trader Brian's question from a couple weeks back. Today, let's consider the inter markets between forex markets themselves and how they relate to one another.

Among the majors currency pairs, GBP/USD, EUR/USD, CAN/USD, AUS/USD NZD/USD and CHF/USD, there are basically three correlated groupings.

GBP, EUR, and CHF are all considered one family, we'll just label them the European Currencies. CAN, AUS, and NZD are all considered one family, we'll label them the Commodity dollars, or comdolls for short. Lastly, we have the USD which essentially stands alone as the counter part to all these. We don't really need a nickname for it.

As a rule, these will often trade in some relation. When commodities are on a run, especially oil, we see the commdolls making bullish moves. Such a trade fits in fundamentally with their production, and also, as oil is priced in US dollars, when it's price is rising, it usually means that the dollar is weakening. As the US dollar weakens, all these commodity currency dollars tend to strengthen as the counter part to the trade.

On the European side, we see similar action. These three tend to be considered more related to one another. First, we should note that when the dollar index is moving, it is moving primarily against the euro which makes up the lions' share of the index. Thus, US dollar weakens, euro strengthens. US dollar strengthens, euro weakens. It is an inverse relationship, or something like a see-saw. But as we often hear that a rising tide lifts all boats, when the euro is on the move up, frequently the swissy and the sterling move right along beside. This gives added volatility to these three apart from the strict interpretation of their fundamentals.

These two schools also often move together, in sympathy moves against the dollar. So if commodities are strong, it can move the whole lot. If equities are strong, they can move the whole lot. If both are strong together as a result of some news that promotes an idea of economic recovery, they all will move up. In the current, environment one of the wild cards however is this: good news out of the US. Not so long ago, good news from the USA would prompt a US dollar selloff, and a currency run up everywhere else. The rationale being that if the US is going to recover, everyone is going to recover. (And if there was going to be a recovery, everybody wanted to be holding the higher yielding currencies against the dollar.) The reason being is that the US was the primary engine of growth worldwide. They purchased what everyone else produced. But things are somewhat different now in the US. Citizens no longer boast massive amounts of equity in their homes against which they can borrow for every toy and trinket under the sun. The US savings rate is rising. This is the death knell to sales, especially as incomes have been falling due to rising unemployment and underemployment. Even if the US recovers, spending will not return to its previously dizzying heights. Many who were just about to enter into retirement have seen massive amounts of their retirement accounts wiped out, never to be recovered...and with very few years left to work.

Without spending, the rest of the world cannot return to its previous peaks of manufacturing and selling success. So now US good news is debated hotly for it's inferences. Will it be the US who recovers and leads interest rates higher? Will the US be the first to emerge from depression? Will the US's gowth benefit the rest of the world? What should we be buying...the USD or the Euro?

The truth is, no one really knows. We have never been at this juncture in world
history before. No one really knows how to fix the current problems under the current theories of economics. And the truth is, no one can. The current theories do not allow for a place in time where debt is so incredibly massive, that it cannot be repaid. Sure, it was ok for certain 2nd and 3rd world countries to default. Because then all the wealth of the developed countries could be funneled to them by way of "loans" and "aid". Which has actually already happened. But who will spare the mighty US? Or the Eurozone? Or Great Britain? There isn't enough money in all the world to bail them out. This is what I mean when I say we have never been at this juncture before. Basic, non-Keynesian, economics says that after a run up like we've had, the only way out is to write off debt or pay off debt and get it out of the system. But that isn't happening on the governmental scale or Central Bank scale. It is happening in private businesses (the ones which don't get bailed out), and in private families (where foreclosures end the game), these are getting rid of debt. But the governments of the world have just continued to add to it; bailouts and purchases and guaranteed loans of all kinds. Until the governments of the world stop spending to try to create sustainable recovery, no recovery is bound to happen. You can't spend your way to wealth.

As such, the markets move in tandem with greed and fear, what they want, and what they are afraid of. When all is said and done, they are the great correlators, and they are the great market movers.

Happy Trading!

Bill
www.thefxtradingmasters.com
bill@thefxtradingmasters.com