The last week has seen the USDOLLAR break its correlation to real interest rates, oscillating around the zero mark (green rectangle). Yesterday, the correlation coefficient (cc) showed a negative relationship between the two series. Nevertheless, that seems to be correcting, with the cc heading back towards zero.
The two had a solid positive correlation (red rectangle), but the CPI release on August 10 (blue arrow) prompted a breakdown of this relationship. However, in our view, this will reassert. Consider the weekly correlation between the two:
Here, the correlation coefficient develops into a strong positive relationship from the week of 14 March (green dashed vertical). This was the week the Fed officially acknowledged quantitative tightening as a policy objective.
The current real rate may be forming another trough. Two weeks ago, a reference candle charted (red circle), i.e. the candles to either side had higher lows. If the real yield closes above this reference candle's high, it suggests a higher rate bias. If so, it will likely support the greenback, keeping the robust weekly correlation coefficient.
A higher interest rate is still plausible because, even though the headline CPI moderated, the median CPI did not. I.e. it remains to be seen just how sticky inflation is.
Senior Market Specialist
Russell Shor joined FXCM in October 2017 as a Senior Market Specialist. He is a certified FMVA® and has an Honours Degree in Economics from the University of South Africa. Russell is a full member of the Society of Technical Analysts in the United Kingdom. With over 20 years of financial markets experience, his analysis is of a high standard and quality.