Why The Euro's Correlation With Stocks Has Changed

       

By Tommy Stubbington
        In recent months, when global stocks have fallen, the euro has usually gained against other major currencies. Until last year, the pattern was the other way around.
        "It's quite clear the correlation has changed," said Andreas Koenig, head of foreign exchange for Europe at Pioneer Investments, which manages $244.1 billion of assets.
        What's behind the shift? The euro's previous relationship with stocks began to reverse in the middle of last year, as investors anticipated the European Central Bank's monetary stimulus program, said Michael Sneyd, a currency strategist at BNP Paribas.
        During the last year, the euro has tended to fall by roughly 0.1% against the dollar for every 1% rise in global stock markets, according to data compiled by the bank. The year before, a similar rise in equity markets corresponded to a rise of nearly 0.4% in the euro, the data show. A rise in stock markets is typically a sign of investors' growing appetite for risk.
        The ECB's quantitative-easing program has driven down bond yields in the eurozone and reduced borrowing costs. Analysts and investors say that has helped turn the euro into a funding currency in so-called "carry trades"--a role traditionally played by the U.S. dollar or the Japanese yen. Now, when markets are steady, some investors borrow euros to invest in assets in higher-yielding, often riskier currencies.
        When markets are under stress, investors repay their borrowings, buoying the euro. Eurozone investors who had been seeking higher returns overseas are also likely to bring their cash home.
        As a result, the euro "benefits if the situation deteriorates," and vice-versa, said James Kwok, head of currency management at Amundi, which oversees EUR950 billion ($1.04 trillion) of assets.
        Mr. Kwok has been selling the euro against the British pound since Greece agreed to negotiate a new bailout with creditors last month.
        In June, as doubts over Greece's eurozone membership grew, the euro made gains against other currencies, then sank quickly when Athens reached an agreement with creditors. More recently, the euro rallied sharply early last week as a big selloff in China spilled over into global markets.
        Pioneer's Mr. Koenig said he increased the size of his bet on a weaker euro as Greece's negotiations with creditors showed signs of progress. He had earlier scaled it back--effectively buying euros--when the Greek debt crisis was raising tensions in markets.
        The recent shift in the euro's behavior could provide clues about where the currency is headed next. If risks around Greece and China continue to subside, the euro could fall as investors re-enter carry trades.
        And a likely destination for their cash is the U.S., given growing confidence that the Federal Reserve is close to raising interest rates, which would boost the appeal of the dollar.
        "Greece has moved to the background for the last few weeks. The focus has definitely returned to central bank policy divergence," said Roger Hallam, chief investment officer for currency at J.P. Morgan Asset Management, which oversees $1.8 trillion. The firm has recently re-entered negative euro positions against the dollar in some portfolios as the likelihood of a September Fed rate rise increases, he said.
        (END) Dow Jones Newswires

        August 06, 2015 08:47 ET (12:47 GMT)

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