Good day forex trading koalas.
Welcome to other review of the correlation between the EURUSD and SP500.
We noted in the Dec 10 review that starting from mid November, the correlated pair started to deviate from the risk aversion model. Under this model, when the risk appetite is strong, US dollar is dumped in favor of higher yielding assets such as equities. When risk aversion occurs, high yield assets such as equities are dumped in favor of traditionally safe assets such as the US Dollar. However starting from mid November, the EUR/USD seemed to strengthen or weaken together with the S&P 500. This suggested that the troubled Euro Zone with it’s deficit crisis might be causing the Euro currency to lose it’s appeal to investors.
Looking at the chart comparison of the EURUSD ( blue ) and SP 500, we once again note that the currency pair is usually more volatile. Typical of currencies. What is more interesting is that the correlation seems to have reverted back to the risk aversion model.
If you are new to the class, welcome aboard! I always mentioned that currency exchange movements are affected by many factors. The various markets are all interlinked and the only way to succeed in currency trading is to get an in-depth understanding of the various relationship.
So why is the risk aversion model back? If you have been reading the daily and weekly EUR/USD reviews, you will notice that confidence in the Euro Zone is recovering. The markets believe that the officials of the Euro Zone are working together to curb the deficit crisis and pledges of support by Germany to do whatever required to protect the Euro currency is encouraging. Furthermore, economic giants like China and Japan have voiced their support too. Therefore with the increased confidence, demand for the Euro currency as a high yield asset is increasing. This puts it together with the other high yield assets such as equities. This enforces the concept that the various markets including the currency exchange are all interlinked.
Having said so, sentiments often change without warning and hence close monitoring must be done. If the Euro Zone continues to strengthen, we will probably continue to see the risk aversion model. If trouble brews in the Euro Zone, the demand for the Euro currency may reduce again.
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