[Fegu]

The downturn in Chinese equity prices through August is notable not just for its brutality (-16% from the August 4 peak), but also its isolation. Over the period that Shanghai stocks have satisfied the conventional definition of a bear market, most global equity markets are virtually unchanged. This global isolation, however, is certainly not apparent in FX markets where intra-day markets in many of the majors have seemed to follow little other than Chinese stocks in recent sessions.

Graph below looks at how sensitive G10 currency pairs are to short term movements in Shanghai stock prices. All possible G10 currency pairs are ranked on the basis of their daily % change correlations in 2009 to date. Not surprisingly, given China’s role in driving global commodity demand, commodity currencies feature heavily at the top of the chart. In fact, the strongest correlations are dominated by AUD and, perhaps more surprisingly, NOK crosses, with EUR/NOK being the single most sensitive of all 45 currency pairs. CAD and NZD crosses are relatively neutral as a result of the former’s strong ties to the US cycle and the latter’s non-industrial commodity mix.

Note also the dominance of USD on the negative side of the correlations - ie as the dominant safe haven currency when Chinese stocks are under pressure. JPY – the only alternative to USD as a safe haven recently – is a much less satisfactory bolt hole when stocks are under pressure in China than it is when the pressure is global. The sensitivity of both AUD and NOK to Chinese stock prices means that crossing these two currencies against one another produces a cross that is almost entirely neutral to Chinese stock prices. In fact, AUD/NOK has the third lowest correlation of all 45 currency pairs in chart below.