Forex Investment and Currency Trading

There is no doubt that the correlation between oil prices and various Dollar crosses has risen notably over the last few years. But it matters how you measure this correlation. For example, if you calculate the correlation between EUR/$ and WTI in levels over the last year, you will get a figure around 95%. This is misleading, however, as the two variables have been trending in the same direction over the period, and that will tend to generate misleadingly high correlations.

To get a better sense of the underlying link, it is more informative to look at correlations in changes. Looking at correlations in weekly changes, to strip out very high frequency daily noise. The latest reading on this measure is 52% for EUR/$, the highest since the creation of the Euro in 1999. For $/JPY the correlation is somewhat lower, at 26%, but still at the high end of the historical range. Furthermore, if we analyze the sensitivity of EUR/$ and $/JPY to oil prices within a factor model framework, the oil term comes out as significant now, while that was not historically the case.