The Bank of Japan surprised investors at the end of January by pushing interest rates into negative territory.
In the normal course of events, that would have been viewed as positive for growth and optimism and a negative for the yen. But markets decided on a more negative interpretation.
The yen strengthened unexpectedly, from around 120 against the US dollar to around 112 by the middle of February.
That hurt the Japanese stock market, which is driven by large export industries. Equities also fell around the globe.
Banks were hard hit as investors focused on the implications for their margins. Sentiment was affected more broadly by the sense that central banks were running out of policy options.
However, sentiment towards risk assets began to improve in mid-February as the focus switched to the European Central Bank’s (ECB) policy meeting in March.
Comments by the Bank’s president, Mario Draghi, raised expectations that a significant announcement would be made.
These expectations were correct: the ECB announced a reduction in key interest rates, an increase in asset purchases of €20bn per month, a six-month extension to the period over which asset purchases would be made, the inclusion of non-bank corporate bonds in the asset purchase scheme, and new targeted long-term refinancing operations with very attractive terms for banks.
This package of measures helped shift the market’s focus away from the implications of negative rates towards measures that might encourage the creation of credit in the real economy.
But, once again, the exchange rate response was unexpected.
The euro strengthened, rather than weakened, in part because Mr Draghi suggested further rate cuts in the future were unlikely.@Image-df29bef8-27af-4079-ae63-bc1018ffe0bb@
The euro and the yen were given a further boost towards the end of March, when the Federal Open Market Committee released a doveish statement and lowered its forecast for future US rates.
In April, attention shifted back to Japan. With the numbers out of Japan continuing to disappoint, financial markets assumed further policy measures aimed at stimulating growth would be announced at the Bank of Japan’s policy meeting towards the end of the month.
Indeed, as the meeting approached, rumours of a targeted long-term financing operation, similar to that implemented by the ECB, built – so it was a surprise when no new policy measures were announced.
It is clear that the actions of major central banks, and expectations surrounding them, remain one of the most significant factors that multi-asset investors need to take into account.
The impact on currency markets has driven performance across asset classes. The stronger euro has meant key European equity markets have underperformed. The weaker US dollar, particularly after the ECB and Federal Open Market Committee meetings, helped commodities to recover from sharp losses and improved sentiment toward emerging markets.