Bold Is Beautiful: ECB and Investment Takeaways
President Mario Draghi took a bold stance at the European Central Bank (ECB) press conference last Thursday. Not only did Draghi announce the timeframe for ending the asset purchase program in 2018, but he also provided forward guidance on the unlikelihood of an interest rate hike until the summer of next year, subject to incoming data. Considering the meeting came just weeks after the Italian political turmoil, it is likely that Draghi was trying to project the most politically unbiased stance of the ECB to the markets.
This was contrary to most analyst expectations, as forward guidance language on rates was expected only at the December meeting. In addition, the projected timeframe for the next rate hike is longer than investors had originally expected. It appears that Draghi has found the perfect balance for the hawks (ending an era of easy money) and doves (strengthened forward rate guidance). The timing of the end of the stimulus is viewed as a trigger for speculation on when the ECB will raise rates. According to the Eonia-dated contracts, it now appears more likely that the first rate hike won’t take place until September 2019, provided inflation is sustainable. This is close to the time that Draghi will retire from his position—October 2019. The market looks as if it is becoming convinced that this is a slightly dovish set of policy changes.
As the ECB’s mandate remains focused on price stability, it shrugged off a series of downbeat macroeconomic data in the euro area and contagion spreading from Italian political risks, drawing attention to the sustained adjustment in the path of inflation as the reason for ending its bond-buying program. According to the latest staff projections for gross domestic product (GDP), growth was revised lower for this year, while the outlook for 2019 and 2020 remains upbeat. The inflation outlook was lifted to 1.7% from 1.4% each year until 2020. It seemed contradictory that the ECB remained optimistic on the forward growth projections despite central bank staff projections for 2018 being lowered to 2.1% from 2.4%. It is also worth noting that the decision to change forward guidance was unanimous, and Draghi confirmed there was a desire to retain optionality shoul conditions deteriorate.
The dovish undertone, coupled with greater clarity from the ECB on the path ahead, seemed to resonate across the markets: The euro dipped more than 1%, while European equity markets closed higher and bond yields in Germany, Italy and Spain declined. European equity exporters, namely the automakers, caught a tailwind from the declining euro, leading the gains on European equity markets after being caught in the crossfire of trade wars.1
WisdomTree has long been advocating that U.S.-based investors could reduce the risk profile of their international investments by focusing on equity allocations in a currency-hedged manner—and not take uncompensated currency risk by always being long the euro. The moves in the euro this year remind investors that the currency is not always a one-way trade higher. We still believe investors could be better served by being more hedged than they are today.
For European region allocations, consider our euro-hedged ETF, the WisdomTree Europe Hedged Equity Fund (HEDJ).
For broad-based international allocations, we have been writing on the benefits of taking a dynamic currency approach, and our latest piece on these strategies can be found here.
1Source: Bloomberg, as of 6/14/18, post-ECB meeting.
Important Risks Related to this Article
There are risks associated with investing, including possible loss of principal. Foreign investing involves special risks, such as risk of loss from currency fluctuation or political or economic uncertainty. Investments in currency involve additional special risks, such as credit risk and interest rate fluctuations. Derivative investments can be volatile, and these investments may be less liquid than other securities, and more sensitive to the effects of varied economic conditions. As this Fund can have a high concentration in some issuers, the Fund can be adversely impacted by changes affecting those issuers. Due to the investment strategy of this Fund, it may make higher capital gain distributions than other ETFs. Please read the Fund’s prospectus for specific details regarding the Fund’s risk profile.
Hedging can help returns when a foreign currency depreciates against the U.S. dollar, but it can hurt when the foreign currency appreciates against the U.S. dollar.
Jeremy Schwartz has served as our Global Chief Investment Officer since November 2021 and leads WisdomTree’s investment strategy team in the construction of WisdomTree’s equity Indexes, quantitative active strategies and multi-asset Model Portfolios. Jeremy joined WisdomTree in May 2005 as a Senior Analyst, adding Deputy Director of Research to his responsibilities in February 2007. He served as Director of Research from October 2008 to October 2018 and as Global Head of Research from November 2018 to November 2021. Before joining WisdomTree, he was a head research assistant for Professor Jeremy Siegel and, in 2022, became his co-author on the sixth edition of the book Stocks for the Long Run. Jeremy is also co-author of the Financial Analysts Journal paper “What Happened to the Original Stocks in the S&P 500?” He received his B.S. in economics from The Wharton School of the University of Pennsylvania and hosts the Wharton Business Radio program Behind the Markets on SiriusXM 132. Jeremy is a member of the CFA Society of Philadelphia.