European yields and euro depressed by dovish ECB

Week of October 27

Last week, we once again saw US Treasury yields rise sharply, hitting their highest levels since the second Fed rate hike in mid-March. The 10-year benchmark rate broke through the 2.45% mark on Wednesday, as markets contemplated potential candidates to lead the Federal Reserve Board when current Chair Janet Yellen’s term expires next February. The possible nomination of Stanford University professor John Taylor—the man renowned for the famous “Taylor Rule”—as either chair or vice-chair was seen as a step towards a more hawkish central bank policy going forward.

On the other side of the Atlantic, long-term interest rates were lifted by the same news. However, the yield increases were more than offset after Thursday’s European Central Bank (ECB) meeting. The announcement that the bank would halve its monthly asset purchases from €60bn to €30bn in January was widely anticipated. But President Mario Draghi’s comments at the press conference after the decision that the programme remained “open-ended” lent support to faltering bond prices, which were further bolstered by a reminder that proceeds from maturing bond holdings would also be reinvested.

Also driven by the news that the ECB’s bond-buying programme might continue for longer than expected and that the bank’s interest rates would remain at their current levels for “an extended period of time, and well past the horizon of the net asset purchases,” the euro depreciated almost 2% against the US dollar. In reaction to the sharp drop, short-horizon risk for EUR/USD rose by 0.26% to 6.76%. The Swiss franc also saw its predicted volatility increase from 6.62% to 6.77%, as the safe-haven currency almost reached parity with the greenback, a level last seen in mid-May.

Meanwhile, short-term risk in Axioma’s global multi-asset class model portfolio dropped to 3.12% as of last Friday, down from 3.35% the week before. The decline was mostly due to a combination of lower stock market volatility and a slightly more negative correlation between equity and FX factor returns. It was therefore not surprising that the developed non-US equity category experienced the biggest reduction of 0.14% in its volatility contribution, followed by US and emerging-market shares, which accounted for most of the remainder.

Christoph Schon, CFA, CIPM

Christoph Schon is the Executive Director, Applied Research for EMEA at Axioma, where he generates insights into recent risk trends with a particular focus on fixed income and multi-asset class analysis. Christoph has been in the portfolio risk and performance analysis space for more than 10 years, having previously worked for Lehman Brothers/Barclays POINT and UBS Delta.