Markets' recovery has been just as impressive, fast and unexpected as the frightening corona-induced market crash. The fact that it has largely been provoked by record high fiscal and monetary-aid packages has not at first appeared to bother investors much. Instead many observers are questioning to what degree the massive central-bank interventions is affecting the performance of different asset classes. How important could a market segment in which a central bank is buying be?
European corporate bonds, which the European Central Bank can buy directly, and the exchange rate between the Japanese yen and the Australian dollar might be seen as examples of two extremes in this respect. The yen is a popular hedging instrument that can typically appreciate in value during phases of rising risk aversion. By contrast the Australian dollar is often an instrument that is thought to reflect the health of the global economy because of the Australian economy's high dependence on commodity exports. In theory, an accelerating global economy (and associated rising demand for commodities) should therefore bolster the Australian dollar. The Australian dollar/yen currency pair is therefore driven more than any other, usually, by a combination of global fundamentals and investor risk sentiment.
As our Chart of the Week shows, the correlation between the yen/Australian dollar exchange rate on the one hand and the risk premium of Euro-denominated corporate bonds on the other has been very obvious since the outbreak of the crisis. Other asset classes, not least equities, have also reflected this: even if central banks intervene selectively in targeted segments, their interventions ultimately radiate across all asset classes.
However, it is questionable whether this strong correlation will persist should the economic recovery lose momentum, despite the expansionary monetary policies of the central banks. Stefanie Holtze-Jen, DWS foreign exchange strategist, notes that currency pairs have detached themselves from fundamentals in a way rarely seen before. "Due to the near-zero interest-rate policy of almost all major central banks, interest-rate differentials have ceased to be a driver of exchange rates for the time being. Risk sentiment has therefore become the chief driver. In our view the yen is currently functioning well as an indicator of investors' risk appetite, especially against the Australian dollar. In other words: on days when risk assets are weak, the yen remains a good choice.
Sources: Refinitiv, DWS Investment GmbH, as of 6/24/20
* ICE BofA Euro Corporate Index - Option-Adj Spread