Forex Market Correlations
Just quickly following up on a question from a subscriber asking what are the most significant or important Forex trading currency correlations? Now, these correlations as we’ll talk about is much more significant than just a simple heat map showing cross currency correlations.
In this video we’ll look at what fundamental, or let’s call it macro economic correlations we can observe in the major currencies. Now the first one is a topic that we’ve talked about many, many times before and that is of course risk sentiment.
Now they are essentially two types of currencies that are sensitive and correlated to changes in the risks, they’re namely high beta currencies, and then of course, safe haven currencies.
Now the Aussie, the kiwi, the CAD, and normally your emerging market currencies like your ZAR, your Mexican peso, Russian ruble, and Chinese yuan are considered as high beta currencies that are expected to appreciate during risk on sentiment, and they’re expected to depreciate during risk off sentiment. And then we also have currencies like the Swiss franc, Japanese yen, and US dollar, which are considered safe haven currency. So they’re expected to appreciate during risk off sentiment, and expected to depreciate during risk on sentiment.
Now this is one of the most important currency correlations to understand from both a macro fundamental, but also a very short term sentiment point of view as well. Then we also have currencies that are correlated to certain commodities, or exports.
Now keep in mind, some of the high beta currencies are often referred to as high beta, which alludes to the fact that they have a higher volatility. And the reason for that is mostly due to the dependence or correlation to specific commodities, which themselves are considered as risky and more volatile acids.
Now certain currencies can be influenced and correlated to certain commodities due to the export dependency. For example, countries that export large amounts of a specific commodity will usually have a strong dependency on that commodity in terms of the economy, and can obviously thus influence the currency as well.
Now, some of the most significant ones are Canada, let’s just quickly get an example for you guys on the screen of Canadian exports. And a good example Canada with the dependence on mineral products, which accounts for about 24% of total exports, and oil making up about 14% of total exports on its own. Now, this will also heavily apply to other oil producing countries. Another example of that would be would be Russia, we can see in terms of Russian exports oil itself contributing 28% of total exports there.
Also another example would be Norway. Another big oil producer. You can see for Norway 26% of exports is crude, and another 26 is petroleum gas. So very, very oil rich countries, which is why we normally see the Norwegian kroner, Russian ruble, Canadian dollar all react strongly towards moves in terms of the oil prices.
Then we also have correlations with something like the Aussie dollar with regards to iron ore. So if we just quickly see Australia, we can see 20% of total exports for Australia basically just comes from iron ore alone. So that is a very important one in terms of the Aussie dollar. Another one there is coal. Coal is a big exports for Australia, also making up about 19% percent of exports. So keeping an eye on those two can be helpful for the Aussie dollar as well.
Any massive drops rises in iron ore prices or coal prices can obviously affect the Australian economy, and can have an influence on the Aussie dollar. Another interesting correlation is the one for New Zealand. And if we quickly open up New Zealand, we can see, and all products makes up about 45% of total exports, of which the bulk of that is the dairy industry.
Now a few years back, a key factor to watch for the kiwi dollar was the GDT index, or the global dairy trade index, which tracks the dairy prices globally. Over the importance of that correlation has dulled down in recent years, and isn’t really a massive mover for the kiwi dollar anymore, but it is something just to keep in mind.
Now, then moving on to more subtle correlations with regards to exports, we can also have a look at Germany. Of course, Germany is a good example where we have 12% of exports only being in the auto industry or cars, that’s any big, or positive, negative news for the automobile industry can affect the Euro to some extent as Germany is the largest contributor of total EU GDP. So when we get comments from the US administration, for example, that they want to place tariffs on European automobiles, that’s obviously going to be negative for Germany, and negative for the Euro as well.
Another subtle correlation with regards to exports is the UK. In the UK, 80% of all exports are actually services to services industry. So, and that’s a very big number for the economy, and that is often why we see things like services PMI matrix being very important for the pound.
Now, then we also have currencies that are correlated or sensitive to export destination. So the first and most obvious one is the Aussie dollar, and its sensitivity to China. Now if we just quickly look at this chart, we can see that for China, Australia only makes up about 5.5% of its inputs, which isn’t a real big deal for China, but comparing that to Australia, from Australia they send over 35% of their exports to China alone, which is a very, very big deal for Australia.
Thus, whenever something affects China whether that’s negatively or positively we can expect some reaction in the Aussie dollar, which is why important economic data points in China can have an impact on the Aussie, and why the trade war and tensions between the US and China is weighing so heavily on the Aussie compared to some of the other more risk sensitive currencies.
Now, this also brings us to something like the pound and Brexit. Now, if we just quickly take a look at this chart in terms of UK exports. Given the magnitude of the UK’s trade with the EU, it shouldn’t really be a surprise why Brexit has been such a big deal for the pound and why it will remain a very important driver for many years to come.
Looking at this chart, we can see that 56% of UK exports goes to the EU, which is why this relationship is so important, not only for the UK but also for the EU as a whole, which is why the current Brexit negotiations with regards to that deal is so important. Now turning back to China, this is also an interesting point to make with regards to China versus the US.
Now, there is a reason why the tensions between the US and China have a far bigger reaching effect than most people realize, and that is because China’s size in share, in terms of the share of GDP on a global scale is just massive. If we have a look at this chart we can see that China makes up 15% of the total world’s exports. Now, even though they wouldn’t like to admit it. The US is a very big deal in the life of China, which is basically 20% of their exports going to the US alone.
So as the world’s biggest exporters, and obviously, the two major economies, any major economic fallout between them will have massive impact on the global trade, and of course where there is positive or negative catalysts on a global scale the risk sensitive currencies will obviously come back into focus.
So I hope that this video has been able to answer some of the questions regarding the important correlations. The important thing to remember about these correlations are that they shouldn’t really be traded in a vacuum.
So it’s never just one thing moving the market or one thing moving a currency.
Yes, correlations are important and can certainly act as a primary driver, but they’re always just one part of the bigger story so to speak that we need to keep in mind. So, any other questions with regards to correlations, as usual, don’t hesitate to let us know.