Interest-rate and currency moves

Last month’s article (“Stock shocks and the dollar,” Currency Trader, September 2007) examined how currencies react to shocks in U.S. equities. The article concluded:

To toss in one more Wall Street cliché, we do not have a currency market so much as a market of currencies.

The same-day reactions in currencies may not be particularly tradable, given that most extreme moves in U.S. equities develop in the New York afternoon, while most extreme moves in currencies are in place by mid-day in London.

If we move to the next-day reactions, which are highly tradable, we see same-direction reactions in the CAD, and rallies in the other currencies only in reaction to big down days in U.S. stocks. By the time we get to the one-week horizon, the same-direction pattern for the CAD remains, as do the rallies for the DEM/EUR and JPY following U.S. stock market sell-offs.

Those who wish to trade currencies on the basis of anticipated changes in U.S. monetary policy following a stock market shock in either direction are advised to be highly selective. Only two patterns really emerge from the data: Trade the CAD in the same direction as the stock market shock, and buy the EUR when U.S. stocks fall.

As is often the case in scientific inquiries, this study raised other questions. After all, if currencies react to short-term interest-rate changes and therefore, expectations, we should expect to see some very statistically significant reactions to extreme moves in short-term interest rates.