BNY Mellon: Hidden Links

BNY Mellon: Hidden Links


Simon Derrick, Chief Currency Strategist, BNY Mellon

  • European banking indices don't always reflect the same forces impacting the EUR
  • Have proved sensitive to pressures in Chinese markets in recent years
  • Could prove a complicating factor for ECB (and EUR) in weeks ahead

Since the financial crisis of 2008 the performance of the European banking system has usually tracked reasonably closely to that of the EUR. However, there have been periods when the relationship has broken down. Understanding why is interesting.

The first breakdown came in 2011 when European banking stocks reacted in a logical fashion to the developing eurozone crisis. Between February and November of that year, the STOXX 600 index fell by over 45%. In contrast the EUR remained relatively stable against the USD during much of this period.

The dynamic driving this was straightforward. This was a period when the gap between US headline inflation and the Fed funds rate ballooned out to the widest levels since the mid-1970s and concerns about the US government debt ceiling were mounting.

Arguably, this drove a period of rapid FX reserve growth (jumping by USD 939 bn or just over 10% that year) which, in turn, fed into increased demand for reserve currencies such as the EUR (at least through the first half of the year).

The second time the relationship broke down (it reversed, in fact) came between 2015 and 2017. The divergence in performance began to emerge in mid-January 2015 and coincided exactly with the introduction of the ECB’s asset purchase program.

As might be expected, this helped drive the STOXX 600 Banks Index to multi-year highs within a matter of months while the EUR collapsed to its lowest levels against the USD in over a decade.

There is an interesting second part to the story, however. While the ECB proved adept at ring-fencing Greece during the crisis that built during the first half of 2015, it’s noticeable that the subsequent downtrend in European bank stocks had the scare over Chinese currency policy in August as its initial catalyst.

Moreover, the steepest losses of all came in January 2016 and coincided exactly with a period of intense devaluation pressure on the CNY. In contrast the EUR remained stable throughout this period.

Since last summer, the correlation between the performance of EUR/USD and the STOXX 600 Bank Index has seemingly built again. However, it’s also noticeable that the downward pressure on the banking index coincided with rising devaluation pressures on the CNY.

Moreover, a degree of stability has returned to the banking index as the devaluation pressures on the CNY have dissipated (thanks, in part, to the reemergence of the Fed "put").

Indeed, there has been a far higher correlation between the performance of the banking index and that of the CNY against the USD than against EUR/USD since mid-December (see chart below).

BNY Mellon: Hidden Links