How Stock Markets Influence Currencies – The Case of EUR/JPY
As we mentioned earlier, if someone wants to invest in a country’s stock market, they first need to exchange their money into that country’s local currency.
For example, if an investor wants to buy stocks in Germany, they’ll need euros to do so.
So when the DAX — Germany’s main stock index — is rising, it often signals that foreign investors are buying in, increasing demand for the euro.
In theory, this means that as the DAX goes up, the euro could strengthen as well.
Using EUR/JPY as a Leading Indicator for Stocks
Although the correlation isn’t perfect, research has shown that EUR/JPY often moves in sync with major global stock markets.
At BabyPips.com, we did a little digging and found that EUR/JPY tends to have a strong connection with stock indexes around the world — including the S&P 500 in the U.S. and the DAX in Germany.
Here’s why:
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The Japanese yen (like the U.S. dollar) is considered a safe-haven currency.
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When confidence in the global economy drops and fear takes over, investors pull out of the stock markets and seek safety in currencies like the yen.
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As a result, the EUR/JPY tends to fall when markets like the DAX and S&P 500 decline.
On the flip side:
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When market sentiment is positive and risk appetite returns, investors jump back into stocks.
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This shift usually causes EUR/JPY to rise along with stock indexes, as traders move away from the safety of the yen.
The Correlation in Action
If you look at historical data, you’ll see that this positive correlation between EUR/JPY and stock markets like the DAX and S&P 500 held up quite well throughout the 2000s.
Both the currency pair and the stock indexes climbed steadily — until the Global Financial Crisis (GFC) hit in 2008.
By late 2007, EUR/JPY had peaked — and so had the DAX and S&P 500. After that, all three started to tumble as fear gripped global markets.
In short, EUR/JPY can be a useful clue to spot what’s going on in the world of stocks — especially during times of strong risk-on or risk-off sentiment.