TheFXSpot: Long-Held Correlations Break - For How Long?

Written by Vicki Schmelzer (Source:

NEW YORK, Dec. 11 (MNI) - Long-held correlations broke down further Friday, with the dollar, U.S. interest rates, and stocks all rising at the same time, almost like "the good ol' days," analysts said.

This was in sharp contrast to the trend of the last few years, where the dollar typically fell as U.S. stock and commodity prices rose and vice versa, they said.

It was not that many years ago that a currency would be in hot demand if its economy were rebounding and its stock market was deemed undervalued, but that was before "the carry trade" took over as the dominant play for many global investors.

From 2005 to early 2008, market players went short low-yielding currencies and bought high-yielding currencies and held these positions, with little impetus to take profit.

The euro and other currencies rose versus the dollar and the yen and emerging market currencies soared, prompting global central banks to intervene to prevent excessive currency strength.

Stocks and commodity prices rose and the dollar fell, sometimes for months at a time without a larger correction.

In the wake of Lehman's bankruptcy in September 2009 and again in March 2009, when the market fretted the prospects of a global depression, the dollar rose across the board on safe-haven demand and stock and commodity prices collapsed -- but the correlation stayed the same.

Direction shifted later in 2009, as risk appetite improved, but up until recently, the game plan of shorting the dollar and going long stocks and commodities continued to be profitable.

Things may have shifted last week, when better-than-expected November non-farm payroll data started players thinking that a positive payroll reading may be around the corner.

A much-improved U.S. jobs picture would increase the chance of the Federal Reserve moving forward its tightening cycle.

This week, U.S. Treasury yields have nudged higher, with the 10-year yield breaking above late October levels (3.575%) to post a high of 3.585% Friday before stabilizing at lower levels.

As the greenback followed yields higher, widespread profit-taking was seen in commodities and emerging markets, especially those countries with commodity exposure.

Next Wednesday's Federal Reserve statement will be closely eyed for any inkling that the Fed might push forward the process of normalizing U.S. monetary policy.

Any larger shift in U.S. Treasury yields, in response, would have spillover implications for the dollar, stocks and commodities, analysts said.

Eonomists at HSBC maintained that the FOMC statement will likely keep the phrase that fed funds will stay low for an "extended period," for three reasons, i.e. "low rates of resource utilization, subdued inflation trends and stable inflation expectations."

The Fed will eventually need to provide guidance on the "potential use of large-scale reverse repos and term deposits to drain reserves, factors which have received more attention of late," HSBC said.

"But doing so in the statement risks sending an unwanted signal on the likely timing of such moves," the economists said.

Therefore, the Fed "may prefer to continue to communicate its thinking on these matters through Fed speeches rather than explicit policy statements," they said.

U.S. 10-year yields closed around 3.55%, down from an earlier high near 3.585%.

Earlier, the 10-year U.S. Treasury yield tested yield resistance at 3.575%, the high from October 26 and also a high from August 21.

With the "double top" in play, a "daily close above this level would be bearish for bonds and project additional gains in yields toward a key resistance trendline drawn off the highs from June and August at 3.65%," said George Davis, chief technical analyst at RBC Capital Markets.

Above that, additional yield resistance is found at 3.72% (Aug. 12 peak), followed by 3.86% (Aug. 7 peak). Yield support is found at 3.39% and 3,18% (double bottom), he added.

In other markets, the euro was trading at $1.4622, on the low side of a $1.4587 to $1.4776 range.

In recent sessions, the euro has been weighed by a combination of rising U.S. yields and concerns about Greece defaulting on its debt.

JP Morgan Chase strategists said the euro "is a buy based on the exaggerated fears of a sovereign risk event, but the timing of re-entering longs is poor given the ongoing back-up in yields."

Their technical analysts maintained that "the euro is still at risk of extending the downside to $1.45 and even the $1.43 handle, where a new base has to form in order to prevent a complete reversal of the long-term dollar bear-trend."

JPMC continued to look for broader dollar weakness throughout 2010 and saw the euro then pressing higher.

The strategists have a March 10 forecast of $1.55 for the euro and a June 10 forecast of $1.62.

On the U.S. stock front, the S&P 500 closed up 0.37 at 1106.41, after trading in a 1101.44 to 1108.38 range. The index posted a 2009 high of 1118.67 December 4, in the wake of upbeat November U.S. non-farm payroll data.

NYMEX January light sweet crude settled down $0.67 at $69.87 per barrel after trading in a $69.46 to $71.20 range.

The front contract last settled below $70 on October 7.

Technical analysts saw scope for crude to retest the late September lows near $65.05.

Spot gold settled at $1114.75/oz, on the low side of a $1110.05 to $1141.90 range.

The precious metal is down 9.1% from the life-time high of $1226.10, posted December 3 and is closing in on initial support at 1100/1102, lows from mid-November.

** Market News International New York Newsroom: 212-669-6430 **


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