Post-FOMC: Market Correlations Unsettled?

A couple of days back, I wrote about the aftermath of the NFP report from last Friday. I mentioned that the way currency markets reacted to the event hinted that the inverse correlation between equity markets and the dollar might be starting to break. I pointed out that the FOMC report could provide the evidence we need to confirm whether the break was true or not.

In the most anticipated box office event of this week, the FOMC left its target rate unchanged at 0.25%, saying that it will leave rates as such for an extended period of time. As expected, the committee acknowledged the improving health of the US economy but cautioned against mounting job losses, slow income growth, lower housing wealth, and tight credit that could slow down the pace of economic recovery. The Fed said that it would likely miss its inflation target of 2% during the third quarter as the economic activity remains to be somewhat weak.

Given that things aren’t completely recovering, the Fed said that it would go on with its debt buying program of purchasing up to $1.25 trillion mortgage-backed securities and $200 billion of agency debt in order to create liquidity in credit markets. The Fed remarked the full amount of purchases would be finished by the end of October, instead of September, reflecting their belief that the US economy is stable enough to survive without any immediate stimulus in the mean time.

The FOMC announcement – which I thought would finally give us the answer to whether the inverse correlation between the US Dollar index and equity markets was broken or not – didn’t really signal one way or another. The USD initially rose against most majors prior to the rhetoric, possibly on the expectancy that the Fed would highlight an advance in the US economy, but failed to continue the move when the actual event took place. It looks like it went back to the “norm” when the greenback reversed against most of the majors as risk appetite took the upper hand on the confidence from the FOMC that the US economy has stabilized.

Under the concept of increased risk appetite, I would have expected that currencies like the AUD, CAD, GBP and NZD would’ve really taken off. At the end of the day, however, when all was said and done, the gains of the high-yielders were modest and far from convincing. “Buy the rumor, sell the news,” perhaps?

Are currency traders confused? On the one hand, despite “less bad” data here and there, they know that the economy remains particularly weak. On the other hand, they are probably wondering what’s next for the economy come October once the Fed’s QE program ends.

Looking back at history, the month of October has been notoriously famous for crashes.

1. October 28, 1929, the Dow Jones Industrial Average plunged 12.8% and another 11.7% the day after.
2. October 19, 1987, the US market lost almost one quarter of its value (500 billion dollars) in the span of a few hours.
3. October 2008, the culmination of the sub-prime crash.

Will the “October Curse” come to haunt us this time around? With 1 trillion dollars on the line, the government has done everything it can to prevent the collapse of the global financial system. Given that signals show we may be at the bottom, then perhaps the US economy does have enough to avoid another setback and limp its way towards recovery come 2010. And maybe by October, we will see if the correlation between equities, currencies, and commodities will continue as they have been during the crisis…stay tuned!

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