Which Interest Rate is Key for the Dollar?

Before the Fed's mid-March FOMC meeting it had already been engaged in purchasing mortgage-backed securities and agency bonds, yet its decision at that meeting to ramp things up and purchase Treasuries was seen by investors as a watershed. It is interesting to re-look at the relationship between the euro and yen and other asset classes with this periodization in mind.

Euro: From the start of the year through March 18th, the euro was correlated (at the level of percentage change) with the S&P 500 a little more than 53%. Its relationship with gold and oil (second generic contract) was insignificant. In terms of US interest rates, the euro had a roughly 25% correlation with the second Fed funds futures contract and the second Eurodollar futures contract and a little bit less with 3-month LIBOR. The euro's correlation with the longer end of the US curve (10 and 30 year futures) was about 16% and 13% respectively.

Since the March 19th FOMC meeting, the euro's correlation with the S&P 500 has slipped to about 48%, while the euro's correlation with commodities has increased (55% with the CRB index), including 49% with the second generic oil contract and almost 35% with gold. The relationship with US interest rates has loosened and the sign has swung to an inverse correlation. The inverse correlations do not appear statistically significant. The absolute levels are generally below 10%, but of note the correlation between the euro and LIBOR is near -28.1%, the strongest inverse correlation we found looking across the US yield curve. This would seem to suggest that the euro's rally may be more a function of the decline in very short-term US rates rather than the sell-off at the long-end of the curve.

Yen: During the first part of the year, the yen was correlated with the long end of the US yield curve. The yen tended to strengthen as the US 10-year and 30-year futures rallied, 54% and 48% respectively. The relationship with the short-end of the US curve was decidedly weaker. The correlation between the yen and the second Fed funds futures contract was about 13% and 20% for the second Eurodollar futures contract. The relationship with LIBOR was inverse. As LIBOR tended to rise in the first part of the year, the yen tended to weaken (-31% correlation). Looking away from US rates, the yen was also strongly inversely correlated with the CRB index (-50% correlation). It was also inversely correlated with the US S&P 500 (-29% correlation).

Since the March 19th FOMC meeting, the yen's correlation with the long end of the US curve has loosened to 48% and 45% respectively for the US 10-year note and 30-year bond. The correlation between the yen and the short-end of the US yield curve is more mixed in post-March FOMC meeting period. On one hand, the yen's correlation with the second Fed funds futures contract was cut in half. On the other hand, the yen's correlation with the second Eurodollar futures contract increased to a little above 28%. The relationship between the yen and LIBOR remain inverse but slightly less than before at a little less than 23%. At the same time, the yen's inverse correlation with the CRB index remained largely steady (48%). Its inverse relationship with the S&P 500 become tighter (from 29% in the first period to almost 43% in the latter period.