Daily Archives: August 6, 2014

Last week’s global sell-off, the worst since January, had all the features that make such market events both frightening and exciting for investors. It serves as a reminder to policy makers of the latent threats to financial stability, and the implication this carries for growth and jobs. It also provides insights for the more bumpy road that lies ahead.

The sell-off was sharp, sudden and generalised. In just a few days, the downturn erased the year-to-date gains for major US equity indices, with virtually every segment – both large and small – experiencing significant losses. To add insult to injury, conventional correlations among asset classes broke down as the spillover of the equity market correction spread beyond corporate credit. Commodities also sold off, as did the safest of all havens, German and US government bonds. As such, well-diversified asset allocations did little to mitigate portfolio risks. Read more

As the Federal Reserve starts tightening US monetary conditions, a key issue is how capital markets will respond overseas, especially in the eurozone. Given the relative size of the US financial system, the rise in short and long-term interest rates on dollar assets can be expected to translate directly elsewhere. Higher yields in the US will attract capital from other parts of the world, thus raising rates there too. The overall impact will nevertheless depend on the reaction of local policy authorities and on the portfolio preferences of global investors.

A year ago, when the Fed hinted at tapering, the reaction differed across regions. In several emerging markets rates started rising, reflecting a reassessment of the risk profile of several larger economies, such as Turkey, Brazil or Russia, leading to massive capital outflows towards safe havens. The eurozone, on the contrary, was not affected much, benefiting itself from capital inflows coming in from emerging markets. Global investors had reassessed their view of the eurozone economy, in light of the interest rate convergence between member countries produced by the European Central Bank’s “whatever it takes” announcement, but also of the concrete progress realised in the implementation of banking union and the prospects for a strengthening economic recovery. As the tail risks in the euro seemed to fade away, international investors did not want to be overweight in one currency only, and a large part of the outflow from emerging markets landed in the eurozone, strengthening the euro exchange rate. Read more