Heat maps and correlation trades, that was the main theme over the past 6 to 7 years. In the charts above, it marks the dominant presence of red and dark blue spots, indicating various pairs of assets are either heavily negative or positive correlated to each other when it comes to price movements. It became known as Ro-Ro or Risk-on-Risk-off mode of financial markets. It ususally referred to commodities, stock markets, commodity currencies and EUR moving higher against the USD in case of risk-on modus. Or, Bund and US Treasuries yielding higher (sold) while more risky bonds such as European peripheral bonds were bought. And vice versa. And they all moved simultaneously at the tune of regularity, as if some preprogrammed trade execution engine is orchestrating the event (no surprise with HFT computers these days). FT Alphaville took up a recent Deutsche Bank research paper which goes into the origin and consequences. We might have landed in no man’s land since a couple of months as far as ro-ro is concerned, a kind of potential transformation intermediate move. And we would like to take it from there with different angles.
When it comes to stock markets, currency pairs and commodities, we have indeed witnessed some disconnecting trends surfacing. And it seems that stock markets have more or less the biggest disconnection while commodities and EUR/USD are still somewhat matched. Just have a look at the S&P500 and the CRB commodity index evolving against EUR/USD since 2007
EUR/USD (orange) & CRB (white)
EUR/USD (orange) and S&P 500 (white)
Let’s have a closer look on the peculiar EUR/USD disconnect and stock markets
1) Remember the USD and the FED being the first to aggressively cut rates to zero, revitalizing the carry risk-on trade (leveraged borrowing @ 0% to invest in risk assets). However, 2013 looks quite different than 2008. All main central banks have with some delay followed the FED in reducing rates (currency wars). And this of course reduced incentives as well to perform carry trades. And this is not only applicable on the EUR (0,5%) but on other important liquid currencies as well.
2) A second possibility might be the following. It used to be that bullish news (in combination with money printing) was good for stock and risky markets, igniting carry trades and sending the USD lower. Last couple of months however, we have seen that bullish news keeps the USD stable and sometimes sends the currency higher, simultaneously with global markets (also the case end of the nineties). Could it be that the focus on more positive economic news has changed the outlook for currency carry traders ?
Tertio, may be we have to take it from another angle or anot…