Euro Flash Crash - Market Correlation Lives On

Includes: FXE, UDN, UUP
by: Zecco

By Paul Quintaro

Early on Wednesday, U.S. futures traded higher. The results of an Italian debt auction came in better than expected, and may have lifted the hopes of traders.

Then, right around 10am ET, the EUR/USD pair began to crash—significantly. The pair moved down roughly 0.60% in about 10 minutes, which is a huge move for a currency pair.

While the reason for this significant move was unknown—there were no obvious headlines—chatter circulated among traders that a downgrade of France was forthcoming.

That rumor had made its rounds for months, so whether or not it was truly propelling the action in the markets is somewhat in doubt.

Still, if Wednesday’s action demonstrated anything it was that the correlation between the U.S. dollar and other asset classes lives on.

When the EUR/USD broke below the psychological $1.30 level, a multitude of other assets followed suit.

The Dow Jones Industrial Average dropped about 1% while the NASDAQ and S&P 500 matched those loses. Commodities were also negatively affected, particularly precious metals, with silver dropping about 4%.

Even oil fell, despite war-like comments between Iran and the U.S. over the possible closure of the Straight of Hormuz—a key geographical passage for the global oil supply.

The U.S. dollar index was up 0.50%, while yields on U.S. treasury debt fell.

This may only continue to highlight the apparent trend—during trading sessions when the dollar has rallied, nearly all other assets have sold off.

Inversely, when the U.S. dollar shows weakness, everything else frequently moves higher.

Is a weak dollar good for the global economy? Or does the possibility of a strong global economy mean that the dollar is less attractive compared to other assets?

The correlation may be motivated more by the second rather than the first explanation. The pattern of a strong dollar/weak other assets trade has continued to hold since the financial crisis of late 2008.

When viewed on their own merits, the U.S. dollar and U.S. treasuries may be seen to have significant problems. The Federal Reserve has already instituted two rounds of quantitative easing (which have coincided with a move lower in the value of the dollar) and some of its governors are pushing for more.

Meanwhile, U.S. policy makers are in a deadlock over resolving the nation’s debt crisis. Recently, the U.S. debt-to-GDP ratio went over 100%.

The U.S. dollar and its treasuries may benefit from the phenomenon dubbed by many commentators as the “cleanest shirt in the dirty laundry.” While the situation in the U.S. may not be positive, the rest of the world could be considered worse in comparison.

At any rate, traders may wish to keep a close eye on the movements of the U.S. dollar index. That asset alone may prove to be the largest single indicator of the rest of the market’s moves.