Is the Euro a Safe Haven ?

Markets are collapsing but traditional correlation is melting down. The chart below shows a clear cut correlation break between the EUR/USD and the DJ Eurostoxx 50. In the meantime, the USD (below DXY) does not react to the sharp fall of gold – which is deemed, among many other things, to be a good hedge against USD weakness. Historically, USD reacts positively to bad outcomes on U.S. equities.


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Both charts raise the question: has the Euro become the new safe haven?

The charts below show higher risk aversion (VIX) comes along with a stronger and positive correlation between Stock returns and bond yield daily changes (lower stock returns => lower bond yields. A relationship that gets stronger when VIX increases). This is a traditional relationship. Yet, the second chart highlights that the EUR/USD still reflects forthcoming monetary policy stances in both the U.S. and Euro-zone.

If we sum up: the equity/bonds relationship is consistent with heightened risk aversion. Interest rates differentials still drive the EUR/USD and don’t point to any mispricing. Yet, gold is disconnecting from DXY and EUR/USD and stock indexes are moving astray.

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The Euro zone has been able to improve the functioning of the Monetary Union last week: Greece will have an interest rate cut from 6% to 5% against the promise of a very ambitious program of 20% of GDP privatization (EFSF loans should now "take into account debt sustainability of recipient countries"). Effective EFSF lending capacity will increase up to 500 b euros. Yet, the EFSF ability to buy bonds on the primary market will be done "in the context of a programme with strict conditionality" which suggests that it remains a liquidity providing program (buy the way, an contrary to debt buybacks with haircuts, buying bonds cannot by itself ensure sustainability … ). Overall, there may be short comings, but this is broadly a widely unexpected step forward in the way to solving the crisis. This may explains the resilience of the Euro against USD even though relative trends in news indexes are clearly misleading (left chart below).

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Past VIX spikes came along with strengthening correlation between EUR/USD and equity prices (dotted orange squares above). This times is different. Even though there are sound reasons (monetary policy, institutional improvements) that would explain a higher EUR/USD in "normal" times the current resilience of the Euro is clearly a sign that it may have – temporarily at least – replaced the USD as a safe haven currency.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.