Currencies Don’t Predict Crashes. But They Do Change the Odds.
Most traders assume currency markets lead equity volatility.
I tested that directly.
Using daily and weekly data going back to 2007, I looked for a consistent predictive edge from major currency ETFs into forward VIX spikes or future equity returns. The result was underwhelming. Currencies don’t reliably forecast the next volatility event.
However, they do move concurrently with volatility regimes.
If currencies don’t predict crashes, they may still be reflecting something structural about liquidity and funding stress in real time.
The dollar sits at the center of the global financial system. When it strengthens sharply, funding conditions often tighten. When it weakens relative to peers, pressure can ease.
So instead of asking whether FX predicts the next move, I’m testing something narrower and more mechanical:
Can Currency ETFs Help Avoid Market Crashes?
The Framework
I tested six developed-market currency ETFs:
- UUP – U.S. Dollar
- FXE – Euro
- FXF – Swiss Franc
- FXY – Japanese Yen
- FXA – Australian Dollar
- FXB – British Pound
Direction matters. A > B ≠ B > A.
That creates 30 ordered pairs (6 × 5).
For each pair:
- If Currency A’s 4-week return > Currency B’s → hold SPY
- Otherwise → hold BIL (cash)
- Rebalance weekly
Walk-Forward Test
To reduce overfitting:
- In-sample: 2007–2015
- Out-of-sample: 2016–2024
- No re-optimization
Most strategies degrade out of sample.
Two did not:
- FXE > UUP
- FXF > UUP
Both rules compare major European currencies, the euro and the Swiss franc, against the U.S. dollar.
FXE (Euro) > UUP (Dollar) (Since 2008)
If FXE’s 4-week return > UUP’s 4-week return, hold SPY for the following week.
If not, rotate into BIL (cash).
- ~7.5% CAGR
- 0.7 Sharpe
- 23% max drawdown
- ~55% win rate
What Actually Changes?
If you divide SPY’s weekly returns into two groups, one where FXE > UUP and one where UUP > FXE, the shape of returns looks slightly different.
Both regimes resemble a normal distribution. Markets remain probabilistic. Nothing magical appears.
But the shapes are not identical.
In the Risk-On regime, the curve is slightly taller and more concentrated around modest positive returns.
In the Risk-Off regime, the curve flattens. The negative tail thickens. Extreme downside weeks become more common.
The Point
Dual momentum does not succeed because it predicts the next step in a neat causal chain. It is not a Markov map of market transitions.
Dual momentum works because it tracks observable shifts in relative strength.
This test proves that funding stress shows up in currency leadership.
Read the full post here: https://quanta72.substack.com/p/avoiding-spy-drawdowns-with-currency
Curious if anyone here uses FX relative strength as an equity risk filter.
Posted Feb 19, 2026, 9:55 PM UTC