To show a market correlation is to show a market correlation. That is about it. The reason I say that is because we can never really be sure which of the pieces of price data in the correlation is leading and which is following. And to go further, even if we did know which was leading we then run into the problem of then “forecasting” where the lead piece of price data is going in order to help “forecast” where the follower is going. Thus, I think correlation analysis is useful, but it must be handled with caution.

In that vein, you have probably heard plenty of people trying to forecast currency prices using a forecast of interest rates. I have been guilty of implying the same in my missives. But in reality, it’s a mug’s game to predict currency action by trying to forecast interest rates. Because as John Percival, of Currency Bulletin said many years ago, and I am paraphrasing: If we can forecast interest rates then why bother with currencies; just buy a seat on the Chicago Board of Trade and retire very wealthy. Wise advice as always from Mr. Percival…

Mr. Percival did go on to say that there is meat when it comes to interest rates, and it flows from the yield and inflation differentials. He said these differentials “seem to be the basic fundamentals of currency analysis.” Change is what moves prices, and “in currencies, changes in real yield differentials are a basic value benchmark.”

So, in that vein, below is a chart of the US versus Eurozone 2-year Benchmark Yield Differential. As you can see, the US dollar index has been tracking closely on the yield differential i.e. as the spread moves higher in favor of the US, the dollar index rises, and vice versa.