Really Useful Correlations

It is not news that news moves financial markets. This blog will publish research on how, when, why, and which news moves what financial markets.

A couple of days ago Tom Yeomans commented on my blog that correlations can be tools for fundamental traders. He pointed me to Mataf who publish a running website update on the correlations of forex pairs.

I looked at these correlations between FX rates for 5, 20 and 100 days. These would be useful for normal markets. But often contagion effects hit financial markets. During periods of high volatility or market stress correlations have a tendency to go to 1 (or -1).

After a major economic announcement, there are, as I have demonstrated, some interesting relationships. I thought, following Tom’s suggestion, I would look at correlations just following announcements. So here are a couple of the correlations that should be really useful to those trading announcements.

As an example, from Mataf the 5, 20, and 100 day correlations between AUD-USD and the USD-CAD were (when I pulled them on Monday, February 05, 2007 at 11:58 PM), 0.21, 0.47, and 0.68. According to the notes “If the correlation is low (below 60) then the currencies don't move in the same way.” Now the time horizon should match your holding period. So what if your holding period is a few minutes after an announcement?

Look at the same pairs 1, 5, 10, 20 and 30 minutes following a U.S. CPI announcement. I have calculated the correlations of the returns in the currency pairs (not the levels). If you are trading this announcement, these are the correlations you should care about. The numbers are -0.9035, -0.8479, -0.6696, -0.7454, and -0.6992.

As a sampler here is the return correlation matrix for 1 minute after an 8:30am U.S. CPI announcement:

AUD	CAD	CHF	EUR	GBP	JPY
1	-0.9035	-0.9429	0.9339	0.9552	-0.9135	AUD
	1	0.9051	-0.8678	-0.859	0.8414	CAD
		1	-0.9796	-0.9675	0.9065	CHF
			1	0.9746	-0.915	EUR
				1	-0.9431	GBP
					1	JPY

And here it is 30 minutes after:

AUD	CAD	CHF	EUR	GBP	JPY
1	-0.6992	-0.8205	0.8551	0.85	-0.8357	AUD
	1	0.7108	-0.6963	-0.6182	0.7065	CAD
		1	-0.9831	-0.9072	0.9329	CHF
			1	0.9318	-0.9465	EUR
				1	-0.8725	GBP
					1	JPY