As discussed in USD as a Systemic Pressure Point, a weaker USD has helped catalyze a global asset rebound. A Bloomberg News’s headline today reads: “Weaker Dollar Sparks Commodities Rally; U.S. Stocks Edge Higher.”A weaker USD takes pressure of Emerging Markets, especially China and commodities producers. In Fig. 1 below we show the negative correlation of the USD Index against most global assets (red links), and simulate a -3σ shock of USD and highlight biggest beneficiaries. The top time series shows that even European equities correlation turned significantly negative against USD in march.
Fig. 1 Cross Asset FNA Correlations -3σ USD predictive stress test
While the broad USD Index trend is down, we have started to observe some negative outliers in EUR and CHF vs USD recently. Yesterday CHF/USD surprised for second time outlier since 12 April.
Fig. 2 FNA Correlations highlighting CHF/USD negative outlier (95% Confidence Level)
It’s worth monitoring continued developments in the FX landscape as a key driver of behind the global asset rebound. Central bankers around the world are likely to encourage a gradually weakening USD for the time being, especially against Emerging Markets currencies.
Oil futures plunged by as much as 6.8% this morning after producers failed to come to an agreement in Doha to limit supplies . Oil’s positive correlation with global equities has been a persistent drag on markets, and indeed Asian equities and global stock futures have started the week in negative territory.
Fig 1. shows the predicted impact of a -3σ (8.7%) plunge in oil using the Cross Asset FNA Correlations map. This shock is broadly negative to global risk assets, and red highlighted assets are most affected (with losses exceeding 95% confidence level VaR). The stress test also shows that US 20+yr government bonds would likely be the preferred safe haven asset (green highlight), with a gain of 1.2%.
Fig. 1. Oil predictive stress test using Cross Asset FNA Correlations
In this short video we explore the systemic impact of an oil plunge on global assets, using the Cross Asset FNA Correlations monitor.
Video 1. Analyzing oil’s systemic impact on global markets (3.13 min)
Last week’s top surprise was the global banks rally, apparently driven by improved Chinese trade data on April 13, highlighting the continued importance of China to global markets. This synchronized global bank rally comes at a cost, however: 70% systematic risk (i.e., volatility driven by a common market factor), which exceeds last year’s Aug Flash Crash levels. Fig. 1 shows systematic risk reaching a new 100 day high on April 13, with green highlighted banks representing positive daily outlier returns (95% Confidence Level).
Fig. 1 GSIB FNA Correlations map highlighting 95% confidence level VaR outliers on April 13
Fig 2. below shows the Cross Asset FNA Correlations on April 13, ranking China large cap equities $FXI as top positive outlier, followed by Financials $XLF. CHF and EUR surprised to the downside vs. USD (red highlight) in a broad risk market rally.
Fig. 2 Cross asset FNA Correlations ranking of outliers on April 13
China’s improved trade data was clearly a big relief to banks and markets globally, but elevated systematic risk suggest caution. High systemic coupling implies that any surprises — such as a renewed oil plunge or a downside Chinese surprise– could result in a synchronized plunge.
The short video below briefly reviews the key dynamics driving the global bank rebound, with a special focus on the increased correlation between Chinese and global banks.
Video 1: Analyzing the Global Bank Bounce of April 13 (2.53 min)
As discussed in last week’s Implications of a weaker USD, we started to observe USD early warning signals since Dec 3 2015 and again in March. Most importantly, the correlation matrix of USD Index ($UUP) against major assets has turned broadly negative, suggesting that global markets would benefit from a gradually weakening USD. Pimco’s head of European FX Thomas Kressin agrees: “The dollar’s three-year advance is coming to an end as central banks recognize a strong U.S. currency is not in the interests of the global economy” (8 April, Bloomberg.com). He further noted that The Fed “is willing to let inflation overshoot the 2 percent target,” not wanting to fall into Japan’s deflationary negative rate spiral. Indeed we alerted that US TIPS were the biggest positive surprise in our analysis of the March 16 Fed Rake Hike Delay decision, suggesting that increased inflation risk is starting to be priced into US markets.
Last week’s cross asset FNA Correlations confirmed a continued weakening USD trend with correlated global rebound. Fig. 1 below shows a series of new 100 day USD Index lows with declining volatility (left) and negative correlation (red links) to all major asset classes which broadly rebounded (green = positive return).
Fig. 1. 8 April Cross Asset FNA Correlations: USD Index negative correlation vs global assets
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The USD Index reached a new 100 day low on Friday, after experiencing a cluster of three negative outliers in March (triple the expected 1 outlier in 20 trading day). Furthermore, an analysis of cross asset correlations shows that USD is now negatively correlated (red links) against every asset class except Japanese equities.
Fig. 1. FNA Correlations: USD is negatively correlated to most global assets
The broad negative correlation implies that a weaker USD would benefits most global assets. Fig. 2 shows systemic implications of a -3σ USD stress test, highlighting assets which would benefit most from a weaker USD.
Fig. 2. FNA Correlations -3σ USD stress test
Conversely, a stronger USD would be net negative to global risk assets, which implies that USD remains the most reliable global safe haven currency.
Given the broad systemic benefit of a weaker USD, however, it would make sense for central banks to support this trend globally. In particular, a weaker USD is supportive of commodity prices and takes pressure off Emerging Markets.
Here’s a short video focusing on USD correlation dynamics using FNA Correlations.
Video 1. Implications of a weaker USD (2.39 min)