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BLOG: the impact of Eurozone volatility on investors

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29/01/2015
It’s been a major week for Eurozone policymakers: ECB chairman Mario Draghi finally delivered quantitative easing in the middle of last week, but any optimism that it might drag the Eurozone from its current malaise was short-lived as Greece elected the anti-austerity Syriza party to power at the weekend.

The new Greek government is threatening to renegotiate – or renege on? – its debt obligations with the rest of the Eurozone.

This is interesting from a political point of view, but should it matter to investors? Perhaps the first point to mention is that quantitative easing has usually made stock markets go up. It may sound trite to say so, but – while its economic merit might be questioned – stock markets like the injection of liquidity it provides. Given that European stock markets were among the worst performing last year, this would suggest they might do better for investors in 2015.

But then investors have the thorny issue of the currency. Another lesson we have learned about quantitative easing is that it tends to devalue the currency. Investors taking a chance on European markets risk losing as much as they gain if the Euro weakens against sterling. Currency markets are fiendishly difficult to predict, but investors worried about the declining Euro could use a currency hedged fund to take exposure to European markets. There are relatively few active collective funds with this option, but a number of passive funds are available.

For investors in the UK, it shouldn’t – in theory – make a significant difference. However, there is one notable caveat: it is likely to strengthen the currency. Given that the European Union remains the UK’s largest export market, this may exert a drag on the economy by making UK exports less competitive. This will affect those companies that rely on exporting to the Eurozone. Nevertheless, if quantitative easing in Europe does work to boost the economy, it may negate some of the effect.

There are plenty of commentators who believe that, in spite of the fanfare, the impact of both the quantitative easing programme and the Greek election will be more moderate than most believe. There is substance to this: the Greeks don’t have a great negotiating position: exiting the Euro would have a savage effect on their economy, whereas it is difficult to see similar suffering on the part of their Eurozone peers. Equally, quantitative easing is no silver bullet and may still fail to jump-start the Eurozone economy. In this situation, everything would stay pretty much as before.

The machinations of policymakers have had a significant impact on financial markets since the credit crisis. This latest round of initiatives is no exception. To date, it has been prudent to invest alongside policymakers – the US when the Fed dropped rates and announced quantitative easing, Japan and the UK when its central banks did the same. European markets may not follow the same path, but history is on their side.

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