All the talk this week was dominated by a small island country in the EU which a little over a week ago most people would struggle to even locate on a map – Cyprus. While the sheer size of the potential bailout is rather minimal, the Troika appears set in principle that they will not continue to lend to insolvent institutions. This was reinforced earlier today when the Troika decided to hike Cyprus’s bailout contribution to €6.7B from €5.8B last weekend, citing worsening conditions. Towards the end of today’s session the Cypriot parliament was scheduled to vote on 9 bills and then meet on Saturday to discuss the deposit levy. Furthermore, after tomorrow’s levy vote the Cyprus President and party leaders are planning to head to Brussels, likely with hat in hand.  

That said, what should be overlooked was the passage of capital controls in the Cypriot parliament merely an hour ago. Thus, regardless of the actual outcome to this weekend’s vote with respect to a deposit levy, this all but ensures that domestic Cypriots will do all they can to pull whatever funds they have left once the banks reopen (date…to be determined). While we could see a positive resolution over the weekend or on Monday and consequently a EURUSD pop higher. One cannot overstate the longer-term implications this decision could have on the rest of the peripheral EU nations and the destruction of confidence in the European banking sector.

But rather than getting too far ahead of ourselves, in order to get a better gauge of whether the recent EURUSD price action should be trusted, we turn back to our previously highlighted overlays – Interest rate differentials and Equity spreads. Interestingly enough, they both imply EURUSD should be trading slightly lower than it is presently (1.2985/90), however they also both made short-term bottoms earlier in the week. This suggests the recent EURUSD bottom around 1.2840/45 made on Tuesday could be a key pivotal level. What’s more, it tested the 200-day sma for 4 consecutive days between 1.2875/80 and held on a daily closing basis. Technically, we would not be surprised to see the Euro try to close the gap lower from last weekend around 1.3075, before finding large offers once again.      

Spread between Italian FTSE MIB & US Dow Jones Industrial Average vs. EUR/USD

Chart Source: Bloomberg, FOREX.com 

Spread between German & US 2-year yields vs. EUR/USD

Chart Source: Bloomberg, FOREX.com

THE CORRELATIONS CORNER (IV): Who’s leading who? Comparing EURUSD and S&P500 intraday
Updated Feb 25, 2012 5:20:00 PM

Earlier in the day the market consensus was for Italy’s Bersani to win and we saw this optimism expressed in the FTSE MIB Index (Italy’s primary equity market index), which was up over 600 points, and Italy’s 10-year yield which was lower by more than 27 bps around 9:30am ET. However, the markets euphoria quickly turned pessimistic when headlines crossed the wires that Berlusconi, not Bersani, was leading the Senate race in Italy. As a result Italian equities plunged, yields soared and the Euro began a rather sharp descent. That said, these market reverberations were felt not only in Italy, but worldwide – It should be noted that the Italian election has still not produced any official results yet.

We saw many today wondering what lead to such a sharp sell-off in the U.S. markets, almost in disbelief that the Italian elections could have such an impact. To break this down in one of its simplest forms, here’s an intraday overlay between EUR/USD and S&P500 March futures¹  since midnight, and as you can see the two moved in nearly lock-step to one another (Correlation = 0.9697). Furthermore, it appeared the Euro was slightly leading U.S. indices throughout much of today’s NY trading session. Now, this doesn’t guarantee if EUR/USD continues to head lower over the coming days that S&P500¹ must trade lower as well (or vice versa), but it does suggest this should be the relationship between the two.

Turning to the charts, the EUR/USD did some major technical damage today as it failed into the 50-day sma (1.3310), then broke through the 100-day sma (1.3120) as well as the key convergence zone highlighted below around 1.3085/65 – Daily 144 & 169 EMA’s & 38.2% retracement of the rally from July 2012 lows. Below present levels sees two key technical points to watch: 1.3030 (bottom of the daily Ichimoku Cloud) & 1.3000 (psychological/barrier/option related and the 2013 low). With regards to the S&P500¹, it broke below the 1495 level highlighted in last week’s TECHNICAL UPDATE, which sets the stage for a potential test of the previous Sept. 2012 highs around 1475/74 initially, and potentially 1460/59 (38.2% retracement of the rally from November) thereafter.

¹ Reference is for informational purposes only and is not offered to US clients

Chart Source: Bloomberg, FOREX.com

THE CORRELATIONS CORNER (III): Equity & interest rate differentials mixed, but could prove ominous for EUR/USD
Updated Feb 21, 2012 7:15:00 PM

After the recent decline in EUR/USD over the past few weeks, we wanted to check in to see how the equity and interest rate differentials look, especially since it was these correlations which alerted us to a potential decline in the first place – see more in update (II) below. As you can see in the charts below, the spread between Italian and U.S. equities have continued their sharp decent and is back at levels not seen since the beginning of October.  This is troublesome because it took out its previous December lows and as such alters the technical bias from a defined “uptrend” (higher highs & high lows) to more of a neutral stance. On the other hand, the 2-year rate differential between Germany and the U.S. has not declined to a similar magnitude, and it remains well above its December lows of -0.31.

So what do we make of this?  Well, when we look for signs of stress or worry within the Eurozone, past experience has taught us to look to the EU periphery rather than the core. Accordingly, this would suggest that we should put a greater emphasis on the equity differential than rates since it is Italian equities compared to German yields – the potentially more bearish outlook for EUR/USD. That said, we would be remiss if we did not note that this could have more to do with politics and the Italian election this weekend, then to the health of the Eurozone as a whole and consequently the Euro. However, we should not completely dismiss this because if Berlusconi’s party were to gain a majority in one of the houses (latest polling data suggests if it were to happen it would be more likely in the upper house), then this could wreak havoc not only in the Italian markets, but also the Eurozone as a whole as their political response and devotion to the EMU (European Monetary Union) could become more unpredictable and this could have an impact on some of the other countries within the EU periphery who were already more reluctant to go along with the gameplan.

As for the technicals, EUR/USD’s 1.3170/65 level highlighted in yesterday’s TECHNICAL UPDATE ultimately proved to be supportive after the longer-term trendline break around 1.3220/10 earlier today. However, should this give way the next level of contention to watch is 1.3085/65, which sees the convergence of the daily 144 & 169 EMA’s as well as the 38.2% retracement of the rally from the July 2012 lows.

Spread between Italian FTSE MIB & US Dow Jones Industrial Average vs. EUR/USD

Chart Source: Bloomberg, FOREX.com 

Spread between German & US 2-year yields vs. EUR/USD

Chart Source: Bloomberg, FOREX.com

THE CORRELATIONS CORNER (II): EUR/USD compared to equity & interest rate spreads
Updated Feb 4, 2012 7:00:00 PM

In November and December we introduced slightly more advanced concepts to the Correlations Corner. First was the idea of comparing a particular currency pair with the interest rate differentials between two countries involved with the pair. Then, several weeks later we followed this up with a comparison to an equity index spread. In the examples we used EUR/USD for our currency pair and then compared it to the 2-year interest rate differential between Germany & US, and for our equity spread Italy’s FTSE MIB Index & the US’s Dow Jones Industrial Average. Our findings showed that over their respective 1-year periods they both produced positive correlations with EURUSD of approximately 0.73 (see more on this in our original updates below) – Accordingly, if the yield spread moves in favor of Germany and the equity differential widens to favor Italy, both in comparison to their U.S. counterparts, then we would presume EUR/USD to be moving in a similar manner and the opposite would also be true. That said, there is no guarantee that this will actually bear fruit, but it is merely our own observations.

Interestingly, we have seen both the interest rate and equity spreads begin to come off over the past week – First in equities (Exhibit 1) and then rates (Exhibit 2). Of course this in itself does not assure anything, however it is a rather ominous sign and could serve as a precursor of things to come . Accordingly, if you have an overall bias on the overall direction of the single currency over the coming days/weeks, then it may be prudent to continue to monitor these spreads in addition to any technical or fundamental indicators.

Chart Source: Bloomberg, FOREX.com

Chart Source: Bloomberg, FOREX.com

THE CORRELATIONS CORNER (I): EUR/USD and Equity spread between Italy & U.S.
Updated Dec 13, 2012 7:35:00 PM

In keeping with a more advanced concept to the Correlations Corner from a few weeks ago, we’d like to introduce the concept of comparing a currency pair with an equity index spread. Moreover, since equity indices tend to be a measurement of investment ‘flow’ into or out of a country, then the spread between two of these bellwethers could be a major driver of longer-term price moves in the particular currency pair involved.

In today’s example we will be comparing EUR/USD and the equity spread between the Italian based FTSE MIB Index & the United States based Dow Jones Industrial Average. The chart below illustrates this relationship over the past year and it shows a positive correlation of 0.7235 – This was also the case with interest rate differentials cited at the end of November (see more  below). While this doesn’t guarantee that if the equity differential between Italy & the US widens over the coming days that EUR/USD should move higher as well (or vice versa), though it does infer this to be the case.

In the chart one can readily observe that EUR/USD and the equity spread have been bottoming and toping around the same time over the past year. While this in itself does not assure anything, it may be something to consider on top of the more traditional technical indicators. Accordingly, rather than viewing EUR/USD in a vacuum, it may be prudent to not only look at the more commonly cited interest rate differentials, but also the equity spread as well, to see if they too are confirming the underlying technical and/or fundamental outlook.

Chart Source: Bloomberg, FOREX.com

THE CORRELATIONS CORNER: EUR/USD and 2-year German-U.S. rate differentials
Updated Nov 30, 2012 1:00:00 PM

In this week’s edition of The Correlations Corner I’d like to introduce a slightly more advanced concept – Comparing a currency pair with the interest rate differentials between the two countries involved with those currencies. Ideally, since interest rates differentials can be a major driver longer-term price moves, it tends to have a positive correlation with that particular currency pair. In today’s example we will be comparing EUR/USD and the 2-year rate spread between Germany (the largest economy in the Eurozone) & the United States.

While I have cited the relationship between alternative markets and currencies on more of an intraday basis of late, the connection between EUR/USD and 2-year interest rate differentials tends to be best reflected on a daily basis – Thus, it’s something to watch over the longer-term. The chart below depicts the two over the past year (November 30, 2011) and as you can see the two have strong positive ties, with a correlation of 0.7344. Now, this doesn’t guarantee if the yield spread between Germany & the US moves from negative towards positive over the coming days that EUR/USD must move higher (or vice versa), but it does suggest this should be the relationship between the two.

Therefore, if you have an opinion on EUR/USD you may want to see if the interest rate differentials are confirming this view. As you can see in the chart below, the two have been bottoming and toping around the same time over the past few months – However, while EUR/USD is closer to its recent September highs, the 2-year rate spread still seems to have a way to go. Accordingly, this could be a reason to for Euro bulls express a bit of caution in the near term unless this spread decides to play catch-up over the coming days/weeks.

Chart Source: Bloomberg, FOREX.com