Tuesday, July 8, 2008

Is the euro the new safety currency?

Boris Schlossberg, Senior Currency Strategist at dailyfx.com makes an interesting observation regarding a long standing trend of a flight to safety of the USD during a major drop in stock market indexes. Yesterday this relationship was reversed at least for a short period of time during which the USD was positively correlated with a falling stock market. Schlossberg concludes that for investors this shift could indicate a major change in the role of the USD and the euro currency in a flight to safety scenario. This is certainly an interesting possibility but one number does not a trend make. Furthermore it is possible that the European economy is weakening together with the U.S. economy which would of course render this new arrangement of a risk assuming euro very unlikely.

Over the past several days the currency market has seen a complete shift in trading psychology. The EURUSD used to be positively correlated with rising stocks markets, as expanding risk appetite generally favored the carry trade in EURJPY lifting the EURUSD in the process. Yesterday however the dynamic completely changed. Stocks dropped like a stone, yet the euro rallied strongly. Why?

One possible explanation is that the euro is now seen by many investors as the safe haven currency replacing greenback’s long held claim to that title. Although the EZ economy shows signs of a slowdown, on a relative basis growth in the EZ remains much better than in the US with Q1 GDP more than double the US rate. Furthermore with its 4.25% yield the unit stands as an attractive alternative to plummeting equities and certainly a superior choice to the greenback’s paltry 2% yield. This change in correlation therefore bears watching. If this is indeed the new trading theme in FX, further declines in equities may lead to more gains for the EURUSD as investors the world over seek the safety of its balance sheet and the attractiveness of its yield.

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source: Euro Recovers After Volatile Night - The New Safe Haven Bid?
Written by Boris Schlossberg, Senior Currency Strategist, dailyfx.com http://www.dailyfx.com/story/dailyfx_reports/daily_brief/Euro_Recovers_After_Volatile_Night_1215509346521.html

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