Euro, Yen and the S&P 500 and Interest Rates: Some Thoughts

In mid-June the dollar-yen rate was correlated with the S&P 500 nearly 91% (r2=0.909). It trended lower until the middle of August, falling to around 31% and recovered to 46% by Sept 10 and has since trended lower and now back to 31%. This is the lower end of the three-month rolling correlation has been since April when it was negative.

The lower trend in the correlation suggests there is another driver at work beside the risk-on/risk-off that has captured the market's imagination. Those other factors could include intervention fears real or imagined. It could be interest rate differentials. The correlation with the 2-year spread remains fairly flat this year, but the 10-year spread has become increasingly correlated and today stands at its highest of the year (r2=0.816). Given the heightened risk that the Fed purchases more long-term assets, it would not be surprising if the dollar-yen correlation with the S&P 500 turns negative again.

The euro's correlation with the S&P 500 is also at an interesting juncture. On a three-month rolling basis it stands near 55%. This means that contrary to conventional wisdom that assumes the yen is more correlated to the S&P 500, the euro currently is. At the start of the month and as recently as Sept 20, the correlation was near 73%.

The three-month rolling correlation has generally been in a range of 20%, seen in late Jan and again in mid-August. Until this month, upper end of the range comes in near 60%. That means that the current correlation is still at the upper end of the range.

In our narrative about the euro, we have generally placed greater emphasis on interest rate differentials than the relative asset market performance. On a rolling 3-month basis the euro's correlation with the 2-year rate differentials is near 84% currently. It has been fairly steady up here since mid-July when it briefly was as much as 95% correlated. In late Jan and early Feb it was inversely correlated by about 23%.