Euro and Stocks--Shifting Sands

My hypothesis is that the risk-on/risk-off matrix that seemed to dominate market development during much of the crisis is breaking down. I suspect it is being replaced by a greater emphasis on country specific macro-economic developments that we place under the rubric of the closure of the output gap.

To this end, I continue to monitor the correlation of the euro and equities as a one dimension of the risk-on/risk-off trades. The euro and equities are higher today and one day a correlation does not make. But the point is that as familiar as that pattern may be, it is increasingly the exception.

Believing that running correlations on the basis of percentage change is more robust, we ran our analysis on a rolling 60 day period. The correlation between the euro and S&P 500 reached a high last November near 68%. Today it is near 42%. The correlation between the Dow Jones Stoxx 600 and the euro peaked last Nov near 63%. Today it is near 26%.Some market participants may prefer to run the correlations on the level of the euro and the level of the equity indices. Here the breakdown is even more dramatic. From a high of more than 95% last Oct, the correlation between the euro and S&P 500 is now slightly negative. The correlation between the euro and Stoxx 600 peaked at almost 92% and collapsed to -65% in Jan and now stands at zero.