It’s been a while since I pulled out those correlation tables and I was in a for an expected surprise.
Yes. The correlations have broken down.
The big basket-happy family trades have started to shun each other in a very short span of time ! Leaving most of us, imperfect human processing machines, quite unable to grasp at the extent of this dislocating move.
QE was a free flow liquidity trade.
Table : QE Correlation Basket 2010- Apr 2013.
The JPM Asia Dollar Index was in boom town,in particular. Note that ADXY is 38.5% weighted in CNY and another 9% in HKD.
Note all the dips caused by the end of QE fears ?
As the story goes, the friendly trades – ADXY, S&P 500, GOLD, SILVER, 10Y UST, EUR, Crude Oil, AUD, gallantly rallied leaving USDJPY and Nikkei behind.
Then the Taper Story broke sometime in April and the holy union was broken leaving ADXY, AUD, GOLD, SILVER, 10Y UST in a sinking lifeboat.
Table : QE Correlation Basket Apr 2013-present
S&P 500 DECOUPLED with her fine friends and took off on her own and the USD trade is back.
We have to recalibrate ourselves for the future (err, actually I said this about a year and half too early – pls do not laugh at my posts last year). All correlations are NEGATIVE now. Biggest losers are the ADXY vs the 10Y UST trade doing a complete U-Turn i.e. HIGHER YIELDS = WEAKER Asian Currencies. S&P 500 is HIGHER if 10Y Yields Are LOWER.
Table : Difference in Correlations Caused By Taper Expectations
The losers are still banding together – GOLD, AUD, ADXY, 10Y UST.
USDJPY and Nikkei are their own tag team and inclined to perform when 10Y UST go higher, Oil is in its own world. Eur has found an enemy in USDJPY and lost a friend in the S&P 500.
Now everything is starting to make more sense. Funds have been pulling out and we are seeing mini eruptions everywhere. The big new trend has not been established yet as the world awaits Judgment Day on QE. That could be Jackson Hole this week or next month’s FOMC or the nomination of the new FED chairman/woman.
The only thing we learn so far is that we cannot do things the way we used to or expect things to go back to where they used to be.