Can somebody explains me the reason why the EUR/USD moves with the Europe stock index and Dow Jones average index?
I do get it that the EUR/USD index moves same direction with the EURO STOXX 50 or DAX because, the Euro STOXX 50 and DAX are based on the euro currency. But, then why the EUR/USD also moves same direction with the Dow Jones that is based on the US dollar market?
I know that the Dow mostly moves same way with the EURO STOXX 50 and DAX but then as the euro gains against the dollar when the European stock index is up, shouldn’t the USD gains as the Dow goes up (the EUR/USD moves opposite direction to the Dow average index)?
after the crisis and after the fears out of the European debt circus, many correlations completely changed. Moving the market into a risk on or risk off environment. The USD, US treasuries and Gold benefit in a risk off scenario. The opposite goes for the world stock indices and pretty much any currency against the USD, probably with the exception of the Yen. Be very cautious when trading if you don’t notice these things, you can really hurt your positions going the opposite direction. Look for these correlations to continue until US treasury yields normalize and other major sovereign yields stabilize, which may be another 2 yrs. Good luck!.
I think more generally the correlation your looking at works via volatility and is related to monetary policy as high(er) interest rate currencies tend to appreciate against low(er) interest rate currencies in times of low volatility and vice versa in times of high volatility (as an example, plot the NZD/JPY – the highest-lowest interest rate currency pair within the G10 – against the VIX). Among practitioners it’s well known that the carry trade loses in times of high volatility, for some academic research see, e.g., Clarida, Davis and Pedersen (2009). Note that the carry trade exploits the forward premium puzzle, which has been related to monetary policy, see e.g., Faust and Rogers (2003). Since volatility is on average higher in down markets, there is also a negative relation between the VIX and stock indices.
Faust, J., and J. Rogers, (2003), ‘Monetary policy’s role in exchange rate behavior’, Journal of Monetary Economics, 50, 1403–1424
Clarida, R., Davis, J., and N. Pedersen, (2009), ‘Currency carry trade regimes: Beyond the Fama regression’, Journal of International Money and Finance, 28, 1375–1389
Thanks to both of you for shedding light via your perspectives on these various macro drivers. Rutger, welcome to the group, and thanks also for providing specific research references to back up your argument. If only more people would take the trouble sometimes…
Gihyun, while I think your question has already been answered, let me point out the now-obvious flaw in its underlying assumption: you note that the EUR appreciates when European indices rise, and drops when those indices fall, and wonder why the USD doesn’t also move in sympathy with U.S. equity indices. However, you also observe that the various global indices tend to move in concert. Therefore, if the behavior of a particular currency were driven primarily by performance of its local equity market, wouldn’t it then hold that we’d rarely get movement in EUR/USD, since both legs would want to move in the same direction most of the time? As Ramzi noted, the USD benefits from a risk-off climate, while the EUR benefits from risk-off. Rutger provided the explanation for why that happens
Thanks for asking your question, and stimulating a good discussion.
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