Giving a sense of its short-term expansion plans, the ECB announced plans to “intensify preparatory work related to outright purchases in the ABS [asset-backed securities] market to enhance the functioning of the monetary policy transmission mechanism.”
These additional monetary policy measures to counter the potentially deflationary trends caused by the euro’s strength lead to a natural question: What about the large flow of assets to European equities banking on a growth recovery? The vast majority of the investment products in the United States targeting exposure to Europe should consider two sources of risk:
1) Equity Market Risk: Exposure to movements in local European equity market prices
2) Currency Risk: Exposure to the movements of the euro and other European currencies, such as the Swiss franc and the British pound, against the U.S. dollar
I reiterate: Why take the additional currency risk when the head of the ECB is telegraphing very plainly that he does not want to see the euro appreciate much further? There appear to me to be real downside risks but no real upside potential for some time.
The ECB monetary easing that was announced—plus further additional enhancements, should they be warranted by a lack of inflation—could be beneficial to growth in the economy, helping companies’ profits.
But these programs potentially render the currency exposure a source of unrewarded volatility. Therefore, one should very strongly consider euro-hedging European equities.
Draghi has taken what we believe to be a positive step for the Eurozone, but again, why would one want to assume euro risk when seeking exposure in this region? We believe that this announcement could make it particularly interesting to consider currency-hedged equities.
1Source: Bloomberg; $1.39 refers to the euro-to-U.S.-dollar exchange rate on May 6, 2014, whereas $1.36 refers to the euro-to-U.S.-dollar exchange rate on June 5, 2014.
2Source: European Central Bank, June 5, 2014, press conference.
3Source: European Central Bank, June 5, 2014, press conference.
Important Risks Related to this Article
Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. Investments focused in Europe are increasing the impact of events and developments associated with the region, which can adversely affect performance.