Macro Insights Weekly: Tracking cross-asset correlations


Common shocks (pandemic), policy response (liquidity injection, rate cuts), and macro drivers have led to some perverse but logical market outcomes.
Taimur Baig, Chang Wei Liang14 Sep 2020
  • Fixed income yields and credit spreads have narrowed worldwide…
  • … while equity prices have soared due to compressed risk premium
  • Along the same time, cross-asset correlations have risen, with widespread rallies this year
  • What happens to correlations as downsides emerge remains to be seen
Photo credit: AFP Photo


Chart of the Week: USD and US rate

A likely driver of the US dollar are US interest rates. If they are high relative to key partner economies, the USD should appreciate; and depreciate when rate differentials narrow. But US rate cuts last year did not cause a rally in USD. So far this year, despite much chatter, the USD’s rise has been modest compared to the rate differential compression, as reflected in low correlation of US 10-yr rates and the DXY index. Perhaps just a matter of time.



Commentary: Tracking cross-asset correlations

We have been tracking the evolution of daily correlations between 20 assets, ranging from equities to credit, government bonds to currencies, precious metals to cryptocurrencies. The motivation is to see if the ongoing crisis is causing a tightening or disintegration of the historical relationship among key financial variables.

Our prior is that correlations are rising, given the common undercurrents. Across the world, common shocks (devastating pandemic and deep recession), common policy response (record quantity of liquidity injection, central banks rates at their floor), and common macro drivers (search for yield, disinflation, weak growth outlook) have led to a series of perverse but logical market outcomes.

Key observations from our correlation analysis:

• The traditional relationship between the USD and US rates has broken down. Higher rate differential used to strengthen the USD; but over the past couple of years rate cuts have not materialised in a major USD correction. Perhaps it’s around the corner.



• Credit correlations between developed market economies and Asian economies, as well investment grade and high yield bonds, are high this year. The degree of pervasive credit correlation is similar to 2016 levels, which we think has been heightened by a synchronous global growth slowdown due to the pandemic, as well as broad tightening of USD liquidity in the emerging economies.



• As the pandemic shock materialised, initially all credit sold off; the rebound has been equally sharp. This suggests that markets are expecting a short and sharp recession, as compared to a long drawn out one that could challenge high yield credit more significantly. We note that in 2018, there was greater discrimination between Asian high yield and advanced economy high yield credits because of the trade war. The Asian credit risk premium has persisted till today, even if correlations between the two have risen back up in 2020.

• We find that treasury yields had only marginal influence on credit until 2018, when higher yields from the US Federal Reserve’s balance sheet reduction led to a jump in EM USD sovereign spreads.

• However, the relationship inverted in 2019-2020 as trade risks drove the Fed to backtrack on tightening, leading to lower UST yields, while EM risk aversion remained high. 2020 saw UST having increased synchronicity with even advanced economy high yield, due to the pandemic shocks to credit spreads and risk-free yields.



• Asian currencies (ADXY) are almost always inversely correlated with Asian USD spreads. In 2017, Asian currencies rose against the USD, coinciding with Asian spread tightening. Both moves reversed in 2018. In 2020, the dollar’s gyration has been mimicked by credit spreads, keeping correlations high. This suggests that both Asian FX and credit are driven by common factors such as cyclical growth outturn, and US monetary policy.

• Emerging market equities tend to take their cues from developed markets, undermining any hope for decoupling. After enjoying a lull in 2018, the outlook for EM equities has largely been a function of VIX volatility.

• We have seen a remarkable rise in correlation between Bitcoin and gold prices. Even though inflation worries are marginal, increasing frequency of shocks and high bouts of uncertainty have fuelled the demand for alternative assets, including crypto currencies like Bitcoin.





In conclusion, underwritten by public sector support, fixed income yields and credit spreads have narrowed worldwide, while equity prices have soared due to compressed risk premium. But at the same time, cross-asset correlations have risen, with widespread rallies this year. What happens to correlations as downsides emerge remains to be seen.


To read the full report, click here to Download the PDF.

Subscribe here to receive our economics & macro strategy materials.
To unsubscribe, please click here.


Taimur Baig, Ph.D.

Chief Economist - G3 & Asia
taimurbaig@dbs.com

Chang Wei Liang

Credit & FX Strategist
weiliangchang@dbs.com
 

The information herein is published by DBS Bank Ltd and PT Bank DBS Indonesia (collectively, the “DBS Group”). It is based on information obtained from sources believed to be reliable, but the Group does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation & the particular needs of any specific addressee. The information herein is published for the information of addressees only & is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Group, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Group or any other person has been advised of the possibility thereof. The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Group & its associates, their directors, officers and/or employees may have positions or other interests in, & may effect transactions in securities mentioned herein & may also perform or seek to perform broking, investment banking & other banking or finan­cial services for these companies. The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation. Sources for all charts & tables are CEIC & Bloomberg unless otherwise specified.

DBS Bank Ltd., 12 Marina Blvd, Marina Bay Financial Center Tower 3, Singapore 018982. Tel: 65-6878-8888. Company Registration No. 196800306E. DBS Bank Ltd., Hong Kong Branch, a company incorporated in Singapore with limited liability. 18th Floor, The Center, 99 Queen’s Road Central, Central, Hong Kong.

PT Bank DBS Indonesia, DBS Bank Tower, 33rd floor, Ciputra World 1, Jalan Prof. Dr. Satrio Kav 3-5, Jakarta, 12940, Indonesia. Tel: 62-21-2988-4000. Company Registration No. 09.03.1.64.96422