AUD/USD: Period of high correlation between AUD and US equities - ANZ

FXStreet notes that in a highly polarised RORO world, the broader risk complex tends to dominate the AUD’s movements. The best measure of this risk sentiment comes from equity markets, which continue to provide the best signal for cyclical FX. Economists at ANZ think this continues until at least year-end. 

“Of particular interest is the correlation between the AUD and equities. Initially, the AUD’s post-March rally seemed as much about superior virus management as improvement in the broader risk complex. Since June, even with Victoria’s flare-up, the AUD/USD has sat stubbornly above 0.70. This suggests the aussie is maintaining its role as the global FX risk proxy, buoyed by extraordinary levels of liquidity and vastly improved sentiment in equity markets. In fact, equities, particularly US equities, have provided a better directional signal than domestic economics or rates in past three months.”

“The number of episodes where the AUD has traded in lockstep with US equities has increased since the GFC. Extended periods of high correlation are typically related to reflationary cycles following economic crises, similar to what we are experiencing currently.” 

“The current episode already looks unusually strong, even by post-GFC standards. The rolling r-squared on a 100-day regression between the AUD and S&P500 is almost at an all-time high. If the aussie were to follow the pattern it set post-GFC, equity market sentiment could remain the dominant signal for at least another three or four months.” 

“With most interest rates at zero and economic data still lacking relevance as a driver, there is a good chance RORO dynamics could persist. There are now fewer sources of distinction in FX markets that are not related to the pandemic. In this type of world, macro liquidity and global risk sentiment will remain more important than domestic fundamentals for the AUD.”