The two blocs

If the world is in fact moving toward two currency blocs, we should see a pattern of correlations moving toward 1.00 or -1.00 against the DXY over time. This does, in fact, appear to be occurring. If we take a set of currencies in the emerging U.S. dollar bloc, such as the Japanese yen, Canadian dollar, Mexican peso, Taiwan dollar (TWD), and Korean won (KRW), we see some rather decisive movements toward correlations of -1.00 in the years since the Euro was introduced. Only the MXN has diverged from this trend in 2005; the Mexican economy has had problems handling the surge of capital from higher oil prices.

The picture of an emerging currency bloc is even more compelling for the Euro. Given the Euro’s ignificant 57.6-percent weight in the DXY, we should expect it to be strongly negatively correlated against the DXY over the rolling 90-day windows, and it does not disappoint in this regard. It diverged significantly only in the months leading up to the introduction of cash Euros, a period in which a number of European citizens were thought to be selling their legacy cash (lira, French francs, deutschemarks, etc.) for dollars to avoid taxes on these holdings.

The more interesting aspect is the steady convergence of the British pound (GBP) and the Swedish krona (SEK) to the Euro. These countries have rejected all entreaties to join the common currency, but their daily movements against the DXY suggest they are nonetheless caught in the Euro’s gravitational field. Restated, the British have a Euro proxy without a seat on the European Central Bank.