Aussie and kiwi rise together as US yields soften: currency correlation

The Australian and New Zealand dollars moved up together at the European Central Bank (ECB) reference rates of 9 October. AUD/USD rose 0.54% to 0.6981 and NZD/USD gained 0.44% to 0.5614, as softer US bond yields gave both currencies room to recover, according to FXStreet.

Mood also helped. investingLive noted that risk sentiment turned positive after President Trump said the US was having productive discussions, a theme our sister site covers in how the dollar eased as Trump ruled out Iran strikes. The recovery was modest. FXStreet said NZD/USD later traded around 0.5605, still consolidating near its recent lows, while Fed rate-hike bets capped the rebound.

What is currency correlation?

Currency correlation describes how often two currency pairs move in the same direction, or in opposite directions, over the same period.

• Positive correlation: the two pairs tend to rise and fall together. AUD/USD and NZD/USD are a classic example. Australia and New Zealand are close neighbours with economies tied to commodities and to Asian demand, so traders often treat their currencies in a similar way.
• Negative correlation: one pair tends to rise when the other falls. EUR/USD and USD/CHF often behave like this, because the US dollar sits on opposite sides of the two pairs. In EUR/USD the dollar is the quote currency (the second one). In USD/CHF it is the base currency (the first one).

Correlation is a tendency, not a rule. It can weaken or break when one country has its own news.

A worked example

Here are the last five ECB fixings for both pairs, with the daily change in pips. A pip is the fourth decimal place, or 0.0001.

On all four days, the two pairs moved in the same direction. That is positive correlation in action.

Now the size of the latest move:

1. AUD/USD: 0.6981 minus 0.6943 = 0.0038, or 38 pips. Then 0.0038 divided by 0.6943 = about 0.54%.
2. NZD/USD: 0.5614 minus 0.5589 = 0.0025, or 25 pips. Then 0.0025 divided by 0.5589 = about 0.44%.

Same direction, slightly different size. Correlated pairs rarely move by exactly the same amount.

Compare EUR/USD and USD/CHF over the same days. EUR/USD went up, down, up, up. USD/CHF went down, up, up, down. They moved in opposite directions on three of four days, but both rose on 8 October. On 9 October, EUR/USD rose 0.18% to 1.1206 while USD/CHF fell 0.32% to 0.8311.

One more caution. Rate expectations differ between the two neighbours. According to investingLive, markets price 33 basis points of Reserve Bank of New Zealand hikes by year-end, with a 59% chance of a hike at the next meeting. News like this can pull correlated currencies apart.

Why it matters for new traders

• Hidden doubling of risk. Holding positions in AUD/USD and NZD/USD in the same direction is close to making one bigger bet on the US dollar. If the dollar turns, both positions can lose together.
• Hidden cancelling. Positions in the same direction on two negatively correlated pairs, such as EUR/USD and USD/CHF, can offset each other.
• Checking a move. If one pair jumps and its usual partner does not, the cause may be local news rather than a broad dollar move. FXStreet, for example, reports that French fiscal concerns kept weighing on the euro.

You can compare the two pairs on a AUD/USD chart and an NZD/USD chart. Remember that the figures above are once-a-day ECB fixings from the ECB, not live quotes.

Key terms

• Currency correlation: how often two pairs move in the same or opposite direction.
• Positive correlation: pairs tend to move together.
• Negative correlation: pairs tend to move in opposite directions.
• Base and quote currency: the first and second currency in a pair.
• Pip: the smallest standard price step, 0.0001 for most pairs.
• Basis point: one hundredth of a percentage point, used for interest rates.