Idea of the Day: Can Draghi influence the S&P 500?

What: The ECB meeting on Thursday 19th July is likely to be a key driver of euro volatility, however, correlation analysis on the euro suggests that it could also be a trigger for S&P 500 volatility. Our ECB preview will be released later today, however, we believe that the Draghi and co. may ease off the recent hawkish rhetoric due to the recent strength in the euro, EUR/USD has risen more than 10% since April.

What: The ECB meeting on Thursday 19th July is likely to be a key driver of euro volatility, however, correlation analysis on the euro suggests that it could also be a trigger for S&P 500 volatility. Our ECB preview will be released later today, however, we believe that the Draghi and co. may ease off the recent hawkish rhetoric due to the recent strength in the euro, EUR/USD has risen more than 10% since April.

Of course, Draghi could resume the hawkish tone that he used in a recent speech in Sintra in Portugal, due to this it is worth looking at the impact a sharp move in the euro could have on other asset classes.

How: We have run a correlation analysis of EUR/USD on Bloomberg’s Correlation Finder. We looked at a range of equity indices, FX pairs, sovereign bonds and commodities using a 120-day correlation. There were some interesting results that we will explain below:

  • Equities: the Canadian S&P/TSX index had the strongest negative correlation with EUR/USD, at -0.78, thus, if we see EUR/USD rally, it could weigh on the Canadian index. The S&P 500 and the Swiss Index had the strongest positive correlations with the euro, both at +0.77. This suggests that when the euro rallies it can boost US and Swiss stocks, possibly because a weakening dollar and Swiss franc can boost their respective equity indices. However, if we see the euro decline, this could weigh on the Swiss index and the S&P 500 on Thursday.  
  • FX: Unsurprisingly, EURUSD has the strongest correlation with the Swiss franc and the dollar index, thus, if we see the euro fall on the back of Draghi’s press conference on Thursday, then we could see an uptick in the Swiss franc and a broad-based move higher in the USD.
  • Sovereign bond yields: Surprisingly, the Japanese 2-year bond has the strongest positive correlation with EUR/USD over a 120-day period. This suggests that as the euro rises, Japanese yields can fall (bond yields move inversely to price). The German 2-year bond also has a high positive correlation with the euro, thus, over the last 4-months’, as the euro has risen, the 2-year German bond rises and the 2-year yield falls. This appears counter-intuitive as it suggests that as the euro rises, German short-term bond yields can fall. Thus, if Draghi talks dovish on Thursday, this does not mean that German bond yields will surge, at least not initially. 
  • Commodities: Brent crude oil and WTI have decent negative correlations with EUR/USD. This is to be expected since oil is priced in dollars, thus, its price can weaken if the euro rises at the same time as the dollar falls, and vice versa.

What about the Dax? In terms of percentage moves, the Dax index tends to move the most out of the major equity indices on the back of a move in EUR/USD. However, the 120-day correlation suggests that the move in the Dax that can be attributed to movements in EUR/USD is only 0.13%, suggesting that other factors are also a key driver of the German stock index.

Overall, this correlation exercise is useful to get a sense of how asset classes move together. Since we expect EUR/USD to be sensitive to the outcome of Thursday’s ECB meeting, this exercise can help prepare traders to get a sense of what other asset classes may also be impacted. 

Join our live webinars for the latest analysis and trading ideas. Register now

GAIN Capital UK Limited (trading as “City Index”) is an execution-only service provider. This material, whether or not it states any opinions, is for general information purposes only and it does not take into account your personal circumstances or objectives. This material has been prepared using the thoughts and opinions of the author and these may change. However, City Index does not plan to provide further updates to any material once published and it is not under any obligation to keep this material up to date. This material is short term in nature and may only relate to facts and circumstances existing at a specific time or day. Nothing in this material is (or should be considered to be) financial, investment, legal, tax or other advice and no reliance should be placed on it.

No opinion given in this material constitutes a recommendation by City Index or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person. The material has not been prepared in accordance with legal requirements designed to promote the independence of investment research. Although City Index is not specifically prevented from dealing before providing this material, City Index does not seek to take advantage of the material prior to its dissemination. This material is not intended for distribution to, or use by, any person in any country or jurisdiction where such distribution or use would be contrary to local law or regulation.

For further details see our full non-independent research disclaimer and quarterly summary.