In recent years, traders have become used to tandem movement between the forex and equity markets. Risk sentiment, as expert analysts dub it, has been the primary driving force behind price action. You probably have seen it many times – whenever equities pick up, like they have in the last few days, the US dollar sells off like ice cream cones on a hot summer day. Conversely, a decline in equities leads to a US dollar buying frenzy.
A quick look at the charts would reveal how the S&P 500, a stock price index comprising the 500 largest companies in the US, and the EUR/USD, the most commonly traded pair in the forex market, rise and fall in almost perfect harmony. With the earnings season in progress, this side-by-side movement of equities and currencies have become stronger than ever. In fact, the positive correlation between the two has gone up as much as 90% in the previous earnings season.
Looking back to last week, we can see that earnings reports have generally come in better than expected so far. Companies like Google, Intel, and Apple have also posted great figures. In fact, word out of Wall Street is that three out of every four companies have surpassed earnings projections for the last quarter – that’s 75% for those of you who hate fractions!
Earnings results have pushed commodities higher, with crude oil trading above the $80 per barrel handle. Stocks are booming as traders and investors are becoming increasingly optimistic that recovery is well under way, leading to a jump in high-yielding assets. Last week’s earnings reports buoyed investor confidence, which pushed the Dow Jones Industrial Average (DJIA) above the 10,000 barrier while the S&P 500 now sits above 1,050 – levels they haven’t hit in over a year!
Assuming that revenues are at par with the previous year, upbeat earnings would indicate that businesses are indeed starting to fare better. Recall that, despite the Fed‘s efforts to stimulate lending by slashing interest rates and pouring massive amounts of money into the financial system, commercial banks remained reluctant to lend. Given the positive earnings among firms, banks could now be more willing to grant loans. With credit more easily available, businesses could start expansion which in turn, could possibly lead to a rise in employment rates.
Risk appetite, as displayed in the surge in the capitals markets, could also prop up consumption since people tend to spend more if they are more optimistic over the economy. In the long run, this would put the Fed in a position which would allow them to raise interest rates. This, in turn, would combat inflation that stems from the increased demand for goods and services.
Now, if you were paying attention above, you would probably have guessed what this has meant for currencies. The rise in sentiment has led to a boost in stock prices, which has left the USD biting the dust. Looking at the EURUSD pair, you’d notice that the pair flew about 250 pips from its opening price of 1.4729 last week. It seems that the 90% correlation is still holding strong…
We’ll find out if this correlation would hold as the earnings season continues this week. Top companies such as Yahoo and Coca-Cola are set to release their reports today. Soda giant Coca-Cola Company would be reporting its third quarter earnings before today’s US session opens. In the second quarter, Coca-Cola beat the expectations and could perform the same feat for another quarter. On the other hand, Yahoo’s earnings are expected to chalk up their fourth consecutive quarter in declines as Google, the number one search engine, continues to outperform its competitors by a mile.
Other earnings reports to keep an eye out for this week are those from DOW components such as 3M, American Express, Boeing, McDonalds, and Pfizer. On Friday, the big shot software company Microsoft is slated to report another quarter of higher earnings.
Compared to last week, a larger number of companies are scheduled to release their earnings reports this week. With this in mind, we could see a more pronounced impact on currency markets. More upside surprises from these big companies could provide more fuel to risk appetite. On the flip side, weaker earnings reports could cause the safe-haven USD to rally. Stay on your toes, fellow forex traders!