US Dollar Breakdown Could Coincide with Major S&P 500 Volatility

09/23/2015 9:00 am EST

Focus: FOREX

David Rodriguez

Quantitative Strategist, DailyFX.com

Given that the correlation between the US dollar/Japanese yen exchange rate and the S&P 500 trades at multi-year highs, David Rodriguez, of DailyFX.com, outlines why he has reason to believe that a breakdown in the USD would likely accompany a much larger movement in global stock markets.

• The US dollar/Japanese yen exchange rate remains strongly correlated to the S&P 500

• A breakdown in the USD/JPY seems likely to coincide with important S&P volatility

• Watch key support levels as markets near a potentially significant turning point

The correlation between the US dollar/Japanese yen exchange rate and the S&P 500 (SPX) (SPY) trades at multi-year highs. Here is why we think this is significant.

Recent volatility in the S&P 500 has coincided on a nearly tick-for-tick basis with moves in the USD/JPY, and indeed, we see reason to believe that a breakdown in the USD would likely accompany a much larger movement in global stock markets. Why?

Correlation Between US dollar/Japanese yen Exchange Rate and S&P 500 Near Record-Strength

chart
Data Source: Bloomberg. Chart Source: R. Prepared by David Rodriguez
Click to Enlarge

Put simply, we see a strong link between which currencies have rallied in the past week versus overall speculative positioning. A closer look at the USD/JPY in particular shows that large speculators severely scaled back USD-longs amid sharp moves in the S&P 500.

Large Speculators Severely Scale Back on USD/JPY (via CFTC Commitment of Traders report)

chart
Data Source: Bloomberg. Chart Source: R. Prepared by David Rodriguez
Click to Enlarge

Similar episodes of financial market panic would likely lead to comparable moves in the US dollar versus the Japanese yen. This dynamic could prove especially significant given that the USD/JPY trades near pivotal volume and price-based congestion support.

USD/JPY Trades Near Critical Support at the ¥119 Mark

Total Buy Volume Executed, Total Sell Volume Executed, Net Volume Executed (Buy-Sell)

Length of bar indicates the sum of Buy and Sell volume.

chart
Data Source: Bloomberg. Chart Source: R. Prepared by David Rodriguez
Click to Enlarge

Last week we argued that the US dollar could see a substantive shift in trend given that many major USD pairs traded near potentially pivotal technical levels. The strong correlation between the USD/JPY and S&P 500 and broader global equities suggests that a move in one could coincide with a similar shift in the other. Or, in short: any sharp S&P 500 declines could point to a USD/JPY breakdown and vice versa.

See the correlations update below to see other important links through the past month of price action.

Forex Correlation Summary

Forex correlations against major currencies, Crude Oil, and the S&P 500 index for the past 30 calendar days:

chart
Data Source: Bloomberg. Chart Source: R. Prepared by David Rodriguez
Click to Enlarge

By David Rodriguez, Quantitative Strategist, DailyFX.com

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