Causation and Correlations

As SP500 is about to make all time highs @ ~1,800 going into the year close, i wanted to discuss / document my thoughts on correlation.

Firstly, the FED is pumping $85 billion per month into markets. The market chatter is 'will they, won't they taper this QE'? If they mention a taper is on the table, it spooks the stock market and bond yields spike.

Let's start with the _US500 / SP500 / SPX chart, i.e. the American stock market:

SP500 (monthly) - relentless bull run



Now compare the SPX (red line) against 10 Year Treasury Note yields:



10 Year Treasuries spiked yesterday to 2.85 as SP500 started to paint red candles; if rates start shooting up, the US would be in a World of pain paying back their debt to the Chinese et al, so they keep pumping up stocks in the hope to keep rates low.



SP500 since week open



ZeroHedge posts many correlations when they occur, here's an FOMC move:



Another interesting correlation on ZH was this chart:



Do you think the QE funny fiat money they digitally print from nothing, goes to help mainstreet and businesses?

So let's now look at the FX market; this is a great site to find correlations:




Here's the FX market compared to SP500 since year open. As SP500 goes up it drags with it xxxJPY pairs (xxx are called the base currencies and JPY is the quote currency). The weakest currency against a rising US stock market are the AUD pairs. Notice how AUDJPY (light blue line) has hovered around year open.




So as the SP500 bubble gets bigger and bigger, it weakens the yen. It's also interesting to summarise that there's a large flow into the safe-haven currency of the swiss franc, the g'ment shutdown a few months ago seems to have deterred investors from the dollar. As SP500 hits all time highs, so is the CHFJPY...

CHFJPY versus SP500 since November month open




I welcome discussion of any intraday correlations against the backdrop of these macro machinations.

John Murphy's book Intermarket Analysis is the seminal work in this line of thinking, although he has a rather negative view of using other markets to predict currencies - like most intermarket specialists he kind of assumes that currency movements can forecast moves in other markets but are almost impossible to forecast themselves.

Basically, people with money must put it somewhere. If not property then stocks. If not stocks then commodities. If not commodities then bonds. If not bonds then stick it in the bank (currency). Any change in the economic situation causes something to increase, the trick is to read those changes and anticipate which market is going to become more appealing given the background situation.

The four major markets - currencies, bonds, stocks and commodities - all respond to each other differently in different stages of inflationary, business and interest rate cycles. Understanding those cycles and how and why they affect those relationships is an incredibly complex subject. Start with a basic risk on/risk off approach, learning which assets benefit from risk appetite and which suffer, then factor in other economic considerations one by one as you discover how they interact with each other in different environments.

As for the fed taper, well, they said they would taper QE when unemployment falls to 7%, ending QE completely at 6.5%. Despite all the yelling and screaming from traders and the media about early/late tapering, the fed has never once deviated from its stated targets. If unemployment doesn't fall to 7%, it won't taper. Simple as that. Don't fall for the mass hysteria - buy the rumor, sell the fact.

Indeed, but wherever the money flows, they'll always be a footprint in the sand, e.g CHFJPY correlated with SP500.

Risk

We can use AUD / NZD daily candles to understand the underlying risk sentiment of the market; when there's risk appetite, these commodity currencies will rise as investors chase the carry trades, particularly against the yen. Conversely, risk aversion leads to dollar buying but this seems to be more so with the swissy as a safe-haven currency.

Today for example (from daily candle open), AUD & NZD are offered whilst CHF is bid, so risk = off. I use 28 charts in my MT4 to create a large cross-section of different base/quote currencies; widget taken from here.



I'm currently looking to buy NZDUSD ahead of the ANZ Business Confidence high impact event on thursday (chart taken from here); there's nice macro divergence to the upside with recent historical highs in the red circle. However, there's a negative trade balance outlook before this event, so expect some retrace first for the first part of the week, but this is a great opportunity to buy into possible risk appetite as commodity currencies could become bid into the year close.



Edit: NZDUSD (1hr chart) - buying opportunity

Wait for some bullish 1hr candle(s) as price is currently picking off buy order stop losses from spike above trendline break and recent fractal highs (red circle).

Update on NZDUSD (1hr)....



Momentum since week open...



So commodity currencies have been offered and safe-haven currencies of dollar & swiss franc have been bid; weekly sentiment has been risk off even though the high impact event of ANZ Business Confidence printed 60.5 versus 53.2 previous (an historical high). AUD pairs have also tanked this week against Private Capital Expenditure q/q high impact event last night with a much better print that spiked AUDxxx pairs before retracing into the London open.

So I'm still gearing towards risk on into December based on commodity macro data releases and these down moves in commodity currencies could be a spike down to pick up more sellers before a risk appetite returns into the year close.

Interesting thread! I think what really matters is if correlation is mean-reverting..

If we now look at weekly momentum, can see that GBP has been ripping north against yen weakness...



However, we need to look at the correlation of SP500 to see if commodity currencies may reverse and SPX starts painting red candles next week. As we approach the week close, SP500 has just broken out of a wedge as it sat above 1,800 for the last few days.



ZH posted this a few days ago:- Whatever You Do, Don't Short Stocks On These Three Days In December...





So in light of the wedge break out and these POMO days in december, it could be risky to trade with an appetite and try buying AUDxxx & NZDxxx pairs which could see more downside as the FED does it's 'thang. However, at these low prices it's tempting to buy these dips on commodity currencies based on strong macro data from antipodean countries.

It seems the FED with it's funny fiat money is winning the battle against commodities but who will win the war?

For completeness & transparency, i'm not afraid to post my crappy trades on NZDUSD (1hr) this week; finally caught one last night, but it's tough trading with risk appetite when commodity pairs kept sinking all week...grrr

NZDUSD - 1hr



I managed to make up my losses and book a weekly profit by creating an AUD buy basket which came to fruition after the spike last night from the AUD high impact event (Private Capital Expenditure q/q - printed +3.6% against forecast of -1.1%); caught lovely move on GBPAUD and bought other AUDxxx pairs.

GBPAUD - 1hr

Mean reversion, no such thing

Look how the SP500 has exploded away from it's 100 SMA, each iteration just gets bigger and bigger; yes it's due for a major retrace, but with this expectation it gives the FED more sell suckers to buy from to pump up stocks even more.

SP500 weekly

If correlation is not mean-reverting, it essentially means that we've put too much weight on their importance!

Anyway Fiatfap, other than the event risk which you're looking to take, what is your broader macro view on NZD? I assume you're trading on a macro strategy?

It seems very much to me that the kiwi would indeed be one of the first to hike rates - yet I think that NZDUSD is not the best pair to express such a view since the dollar risk in the denominator has a lot of uncertainty

I am pretty uncomfortable with your statement:
I think the crux of the issue with the 10y yields has to do with the mortgage market, and not to do with fears of repaying their debt. Furthermore US government deficits have been on a downwards trend...

Yes, you're correct: correlation = mean reversion. My previous post was analysing a single entity against it's own movement, which is diverging upwards from its median, but if we compare different instruments, then there should be correlation.

Currently, as SP500 goes up then AUDxxx pairs go down; so like a coiled spring, a snap-back to their median means SP500 goes down and AUD goes up, e.g. let's look at EURJPY compared to SPX, to see how reversion machinates...

EURJPY versus SP500 since year open

Nice correlation, as they both are going up and the fractals kind of match, but it seems as if the two lines are diverging from one another towards the right as the white space between the lines is increasing.



EURJPY versus SP500 for past ~8 years

Interesting to now compare the macro viewpoint; few years ago, the two lines were diverging (grey trend lines) and it seems they're now starting to climb together (green circle). If we look way to the left, the correlation is ~100% before Lehman collapse in 2008 marked by big spike @ 57 on the bottom axis, i.e. 57 months = 5 years ago = 2008.



So a carry trade (EJ) was linked to SP500 until 2008, which then smashed the correlation and only now are the instruments merging into a common flow again.

I have no broader view only the signals i get each day from my app; earlier this week the market was marginally risk on from the monthly open (as we're heading towards end-of-month candle close), so commodity currencies were trying to bid. I then went through the FF calendar charts and found a NZD event which i thought could have fueled the fire to reverse this current risk aversion...it didn't happen and the dollar and swiss franc kept bidding up mid-week which dragged AUD & NZD lower.

I'm a contrarian trader, can't help myself So when i look at how the GBP has recently been shooting to the moon, i'm looking to sell. I had some AUD buy signals early in the week and so it was an ideal time to throw some shit at the wall hoping some would stick, so i did a sell on GBPAUD and i got lucky, but the AUD news could quite easily have gone horribly wrong.

Gold seems to have found some minor support @ $1,240, so this could be a platform to lift commodities and tank the SP500 going against a back-drop of this week's risk on hint that never played out.


I think negative rates are the agenda, a glorified Cypriot bail-in, to feed the greedy bastard banksters. The trend is very obvious if you compare all central rates:


link


Not too sure about anything that comes out of america; their BLS et al seems to be something that Baghdad Bob would be proud of.

Much like in the UK, house prices are rising again to higher highs, it seems we've been here before but alas nothing was done. Giving loans & mortgages to anybody and everybody to create serfdom and then when it all goes tits up, they get bailed out ad infinitum; where's the due diligence & risk assessment for applicants? Where are the prosecutions and custodial sentences for fraud (PPI for example was extortion)?

EUR inflection buy signal(s)

Spoke about EURJPY & SP500 correlation earlier in post 11; checking my charts, I found these big inflection points on EUR pairs going into the weekly, monthly and yearly close.

Pay particluar attention to EURJPY as it tests a 4 year high and EURNZD has already shows strength by breaking a 4hr double-top. So if risk remains off tomorrow, then expect EUR to gain strength into all these high timeframe closes.

Also, all the charts below are bid except EURGBP which is testing lows, so GBP is much stronger than EUR, despite euro strength everywhere else. Will GBP have the strength to push EURGBP lower against all these big inflection points, or will EURGBP bounce north and follow other pairs on its journey north?

So watch SP500 tomorrow - if risk remains off and SP500 makes historical highs then scalp buy EURJPY as it will mostly likely break 4 year highs on monthly.

EUR / AUD - Daily


EUR / CAD - Weeky


EUR / GBP - 4hr


EUR / JPY - Monthly


EUR / NZD - 4hr


EUR / USD - Weeky

Interesting to note there's been a +215% change in EURO interest rates, so my previous post still remains valid as these key levels could be breached to push further strength into EURxxx base pairs.


There's also a correlation with this week's news calendar showing EUR at the top.


Market is currently risk on with NZD at the top and yen weakness; however, USD is also showing strength which it shouldn't if the market is risk on...

Risk appetite / risk on = dollar down | commodity currencies (e.g. CAD, AUD & NZD) up
Risk aversion/ risk off = dollar up | commodity currencies (e.g. CAD, AUD & NZD) down



Summary
Market currently risk on, so EUR pairs will sell-off, but EUR inflection points from previous post could still be tested as EUR may gain strength this week from the upcoming news events and higher interest rates will see money flowing into the euro to chase higher yielding intraday rates.

So look to buy EURxxx in the short-term but keep your eye on NZD pairs that could become bid as long term risk appetite returns into the year close.

Grasping at straws, but it's sometimes interesting to see how price moves away from wedge breakouts...

SP500 - 1h


On the SP500, I've drawn a triangle around key datum points (white circles) and the triangle projection at the red line shows the harmonic conclusion of this wedge pattern. You'd expect price to have bid further north from this break-out, but it's only approx 6 hours away from the triangle apex on the right, so it shows an underlying weakness in buying intent, as price has been hugging the top of this wedge too many times; Sam Seiden (webinar links) calls this the 'chopping of the tree', where each chop weakens the integrity of the support (or resistance).

However, from this post there are some huge POMO days in December, so the FED will start pumping up stocks to maintain the illusion of a recovering economy, just don't question the $17 trillion debt

Politicians are full of bullshit, so it's important to understand the difference between debt versus deficit. Imagine you have a $3,000 overdraft on your bank account - this is called your debt. If you now go over-drawn on your overdraft by $50 you now owe the bank $3,050 - so you're debt = $3,050 and your deficit - $50. If the next month you borrow another $10, your debt now becomes $3,060 and your deficit will = $60.

What politicians then bullshit about is the fact that the deficit on month 1 was $50 and month 2 = $10, so they'd say there's been an 80% reduction in deficit spending. However, they'll never mention the fact that the debt has still gone up and will be impacted by compound interest. So whilst deficits may go down here and there, the underlying debt will never go down...especially $17 trillion worth of fiat debt.

Unfortunately, the only way out of debt..........................war on a big scale to rebalance the books.

According to Kondratiev wave theory, we're overdue for a correction. Stocks were making higher highs in 1920's (roaring twenties) followed by a market collapse and the great depression (started in 1930 and lasted until the late 1930s), something then happened in 1939! So look at the SP500 with different eyes as it makes all time highs; there will be a point where enough suckers are duped and the big money can unload their positions which will cause a lot of economic pain. After that, well history repeats itself...

Edit: Just re-read the above and i do like to rant Basically, the SP500 looks like it wants to drop (and it probably will) but once red candles are painted on higher timeframes (1hr+) then the FED will start doing their POMO 'thang are SP500 could hit 5,478 (or whatever)...seller beware!

As i type this, gold has just made a 3-month low at 1222, which could lead to further downside to test some longer timeframe support; there's a confluence of a monthly trendline and 50% fib support at 1080.

Gold - Monthly


So with a bearish hat on commodities and previous analysis of EUR strength this week, a good trade could be buying EURAUD. On weekly, the Andrews Pitchfork shows upper trendline resistance 5,000 pipettes away so risk off could still play out this week and EUR buying could be a good way to hedge against this risk aversion.

EURAUD - Weekly

COT commodity correlation

Noticed copper showing some interesting 'big-boy' positioning. It's now testing a huge 4 year trendline from 2009 and commercial hedgers are positioning long from a previous high (green lines in bottom window); this exacerbates risk aversion, i.e. weakens currencies like AUD & NZD. Commercial hedgers trade opposite of the underlying trend and they know their market better than anyone and they seem to be hedging for a copper drop - all other metals give nothing away.

Copper - Weekly


Compare & contrast

If you look at the red circle, we can see a similar hedging of the green line making a higher high, but this preceded a huge uptrend and since COT data is always lagging by days, these signals are to taken with extreme caution!

Currency Strength Comparison

If we compare all currencies since the week open, we can see that NZD (green line) has been the strongest; JPY (yellow line) has been the weakest. All other currencies are range-bound around their week opens, so it's been a flat market monday, except for NZDJPY bid.

EURAUD - buy

Small tester on 5min with 300 pipette stop loss from analysis here as there's some upside for EUR if risk remains off and commodities sell off this week.


Higher Timeframe Support / Resistance


Update
Got taken out, but it took double my stop loss with a spike...what's the point of using stops eh?!I'm very suspicious how easy price went through those supports, so will wait before placing another buy if indeed i do; I use Alpari UK btw.


Update 2
I placed a buy stop order and waited for price to come back to my previous attempt - it's already been picked up. If i can get it to break-even, i'm looking to swing trade into the week.

Working my way through the posts above - good discussion.

At the risk of blowing my own trumpet ... I've written a MTF Correlation indicator for MT4 - you might find it useful for what you are doing here. I've put it in a thread under the platform tech "zone" of the forum. The thread is here (http://www.forexfactory.com/showthread.php?t=453930). There are 2 indicators:

An oscillator (below)



and a MTF table (below).



Hope you find it useful.
I'll get back to reading the thread!

Cheers,
ninety47.