Be Careful! Currency Correlations Change!

The FX market is like a schizophrenic patient with bipolar disease who eats chocolates all day, has severe sugar highs, and has erratic mood swings all day.

We aren't exaggerating in the least.

Currency correlations between currency pairings can be strong or weak for days, weeks, months, or even years, but they can fluctuate over time, and they can alter when you least expect it.

Currency relationships that are strong one month may be quite different next month.

Take a look at the table below for further information.

Compare the coefficients for a certain pair across time periods.

Is there anything you've noticed？

They're mostly different across the board (thanks, USD/JPY!) and change from one time period to the next. And they shift in every way.

The takeaway here is that currency relationships are subject to change, and they do so regularly.

And they can vary dramatically in a short period of time, as seen by the EUR/USD at the 1 Month and 3 Month intervals.

That's quite a swing!

Make sure you're informed of the current currency connections because of the currency market's frequent attitude fluctuations.

The connection between USD/JPY and USD/CHF, for example, was 0.22 over a one-week period. This is a relatively low correlation coefficient, indicating that the two pairings have little in common.

When we look at three-month data for the same time period, however, the figure rises to 0.52, then 0.78 for six months, and ultimately 0.74 for a year.

In this case, you can observe that the long-term correlation link between these two pairings has “broken up.” In the short term, what was once a strong favourable relationship has drastically eroded.

They would have felt they were incompatible if they were a genuine couple who had just dated for a month or less.

They had no idea that the passion may flare up later!

Here's an illustration of how currency correlations may alter and move about when looking at EUR/USD and GBP/USD.

With a 0.94 coefficient, the one-week timeframe demonstrates a fairly significant link!...

However, this link deteriorates significantly in the one-month period, dropping to 0.13, before rebounding to a robust 0.83 for the three-month period, before declining to a poor correlation in the six-month following period.

Here's an extreme illustration of how currency relationships may shift dramatically.

Take a look at USD/JPY and NZD/USD, for example...

Their correlation coefficient over a year was -0.69.

This suggests a moderate to strong link between the two variables.

However, when you check at their one-month correlation, you'll notice that the correlation coefficient has flipped!

So be cautious.

Currency correlations shift for a variety of causes.

These can range from a country's interest rate changes to monetary policy shifts, as well as any collection of economic or political events that reshape traders' perceptions of a currency.