Now Fueled by Weaker EUR & JPY, Global Equities Run Higher
- As market volatility rises, it's a good time to review risk management principles.
"Risk redux." That's about the only way to describe price action overnight, as the fall in the Euro and the Japanese Yen has paved the way for higher equity markets in Europe and Asia. Likewise, peripheral yields in Europe have moved lower. At the same time, the US Dollar has broadly moved higher while US equity futures have gained ground. We've seen this movie before. This is the portfolio channel rebalancing at work. Markets are acting like they're front-running more monetary easing from the European Central Bank and the Bank of Japan.
As we’ve previously written on the portfolio channel rebalancing effect with respect to ECB easing, “In a truly bullish world driven by QE portfolio rebalancing channel effects, the Euro would depreciate amid lower yields and stronger equity markets (something that played out from December  through early-March ) (or vice-versa: the Euro appreciating amid higher yields and weaker equity markets, something that played out from March  through June ).”
Markets today are sitting on the 'good side' of the fence, with weakening low yielding currencies paving the way for higher equity markets. The feedback for the Euro and the Yen, of course, is through foreign capital flows: as foreign investors take on EUR- or JPY-denominated assets onto their balance sheets, they need to hedge off the currency exposure through the spot or forward markets. Otherwise, for example, a portfolio manager could gain +10% on the German DAX, but if EUR/USD fell by -9.1% or more over that same period, the unhedged gain would be wiped out on the currency conversion once repatriation occurred.
If the Euro and the Japanese Yen are about to become utilized again as indirect monetary policy tools, the behavior exhibited thus far yesterday and today - however short-term in nature - in context of commodity prices moving steadily higher over the past few weeks (of note: Crude Oil, Lumber, Iron Ore, and Soybeans - agricultural, energy, and metals alike) suggests that risk appetite is building.
If you haven't yet, read the Q2'16 Euro Forecast, "EUR/USD Stuck in No-Man’s Land Headed into Q2’16; Don’t Discount ’Brexit’," as well as the rest of all of DailyFX's Q2'16 quarterly forecasts.
--- Written by Christopher Vecchio, Currency Strategist
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