In a note on Friday, MS said that a range of currencies with strong links to commodities reached correlation levels of 35% to 55% against the dollar in 2009, compared with a range of 10% to 25% three years earlier. The highest correlated currency was the Canadian dollar, closely followed by the Brazilian real, Australian dollar and Norwegian krone.
The rise in cross-market correlation was caused by spiralling risk aversion and massive liquidity creation in the wake of the financial crisis, with correlation levels tracking short-term money market rates, Morgan Stanley wrote. Currencies with links to oil and copper showed particularly high matching levels with the dollar.
Correlation has dropped dramatically in recent weeks, with the Canadian dollar one of the biggest movers as it slipped to pre-crisis levels. The cause may be stretched commodity prices – the decline accelerated as oil moved above $95 a barrel.
“Concerns about demand destruction from high prices may be hurting investor sentiment, offsetting the positive impact of the price gain on the currency,” says Ronald Leven, an analyst with Morgan Stanley based in New York.
The decline in commodity currency correlation was also likely part of broader normalization of trading patterns as central banks moved to withdraw liquidity, Leven says.
The exceptions to the trend were the euro and Norwegian krone, where correlation with the US dollar has continued to rise over the past three months.
Investors looking to play the correlation decline might focus on the Brazilian real versus the euro via a swap, Morgan Stanley suggests.