First of all, lemme explain what I mean by “risky assets”.
Risky assets are basically just higher-yielding financial instruments. Whenever you read about riskier assets, it normally refers to equities, futures, and higher-yielding currencies like the euro, pound, and Australian dollar. These assets normally have higher yields in order to compensate for the inherent risk of holding these assets.
Since the beginning of the financial crisis in 2008, these types of assets have pretty much moved in tandem. Whenever everyone was risk averse, riskier assets would come crashing down as market players would run to the safety of the dollar. When optimism started to build up, we’d see the opposite happen.
In recent months however, we’re starting to see a different story develop.
While U.S. equity markets and comdolls like the Aussie have been on the rise, the euro has actually been struggling.
The divergence has actually been even more pronounced over the past three months. While AUD/USD has managed to stay above parity and the S&P500 has consistently been trending higher, EUR/USD hit as low as 1.2050 before retracing recently.
It seems that the euros woes started back in June, when European leaders decided upon a growth based strategy to accompany the numerous austerity measures that euro zone members have been implementing.
Combining this with the decision to give Spanish banks a bailout, it gave the markets the impression that the Troika would do “whatever is takes” (Mario Draghi’s words, not mine!) to save the euro zone. Of course, the markets have taken this as a sign that the ECB may continue with aggressive bond purchasing and a prolonged period of low interest rates.
In turn, this has made the euro fundamentally weaker as compared to other risker assets. If you were an investor looking to make a bigger bang with your buck, would you bet big on a currency that’s been on the brink of collapse or on other assets that are more fundamentally sound? Yeah, that’s what I thought.
Going forward, we may see this divergence continue to play out and widen further. Remember, in times of low interest rates and excessive liquidity, companies take advantage by taking out loans to fund their projects, which in turn could lead to higher profits and stock prices.
Meanwhile, low interest rates and persistent bond purchases will only make the euro less attractive to investors.
For now, let’s see how the markets react once the summer season comes to an end. If European officials can come up with a solution that satisfies market participants, who knows, we may just see the euro buck the recent trend and follow the lead of other higher-yielding assets.