Euro and Yen and the S&P 500: Correlations Revisited

We continue to track the correlation of foreign currencies and the US S&P 500. There are two noteworthy developments we bring to your attention today. Methodologically we look at percentage change of the foreign currency and the percentage change in the S&P 500. The result is the correlation of returns, which is what is important to investors.

Over the past 60 day's the correlation of the euro to the S&P 500 has fallen to its lowest level in a year at just above 0.41 today. Recall that the correlation reached a record high late last year a little above 0.85. The 30-day correlation is still lower at 0.34, which indicates the relationship is even weaker more recently.

The other noteworthy development is that the yen's correlation (not dollar-yen, but the yen against the dollar) with the S&P 500 is at its lowest level since September 2010 today. The 60-day correlation stands at almost -0.45. At the extreme last year, the 60-day correlation did not fall through -0.40. The record inverse correlation appears to have been set in late 2009 near -0.81.

In part, these developments reflect the significance of the European debt crisis driving the euro. It lends support to our claim that the risk-on/risk-off matrix has broken down. On the other hand, the yen's increased inverse correlation seems to underscore the special role of the yen. It is not a safe haven in the sense that foreign investors flock to Japan when the capital markets appear particularly fragile. Instead, when anxiety is running high, it appears that Japanese savers do not recycle their current account surplus (driven by the investment income balance more than the trade balance).

Indeed as the European crisis has intensified over the past two week, Japan's MOF flows show foreigners were net sellers of Japanese stocks and bonds (no apparent safe haven flows there). While the week-to-week flows do show some volatility, since mid-March, net-net Japanese investors have not purchased foreign bonds or stocks.