Euro flows reveal shift in sentiment as losses mount
The international appetite for euro- zone financial assets that underpinned the local currency the past two years is beginning to erode.
While broad data showing real-time flows into and out of the region’s stocks and bonds are hard to find, strategists point to items such as U.S. exchange-traded funds, which pulled $1.1 billion from European assets this month, the first outflow since April 2013, data compiled by Bloomberg show. Bonds of Italy and Spain that yielded as much as 7.05 percentage points more than Treasuries two years ago now pay less than their U.S. counterparts, diminishing their appeal.
The result is the euro’s biggest monthly loss since February 2013, and Morgan Stanley said this week selling the 18- nation currency remains the surest bet in the developed world. Rather than a cause for concern, the European Central Bank may see weakness in the euro as a welcome development as it tries to avoid deflation and spur exports to boost the economy.
“The euro is under pressure,” Ian Stannard, the head of European foreign-exchange strategy at Morgan Stanley in London, said in a July 29 phone interview. “Portfolio flows have started to slow down into Europe as yield differentials have come right down.”
Rate Reductions
The euro has fallen 2.1 percent in July, touching $1.3367 yesterday, the weakest level since Nov. 12. It traded at $1.3398 at 12:30 p.m. in Tokyo. Morgan Stanley reiterated its year-end forecast of $1.31 in a July 29 report, and said it expects the euro to weaken toward $1.24 by the middle of 2015. Median estimates of more than 60 strategists surveyed by Bloomberg are for declines to $1.32 and $1.28.
ECB President Mario Draghi contributed to the exodus by cutting interest rates on June 5. It took time for the reductions to work through the system, with the euro closing at $1.3595 on July 4, little changed from $1.3599 a month earlier.
Even with the recent losses, the euro has still gained 0.5 percent in the past 12 months against a basket of nine developed-nation peers tracked by Bloomberg Correlation-Weighted Indexes. It remains 3.9 percent overvalued versus the dollar, based on the Organization for Economic Cooperation and Development’s measure of purchasing-power parity.
Stimulus Bets
The shared currency climbed to a 2 1/2-year high of $1.3993 on May 8 as international investors piled into the region in anticipation of further stimulus by the ECB. While that supported euro-zone stocks and bonds, it proved a headwind to exporters and made it harder to spur inflation, which slowed to 0.5 percent in June, below the ECB’s aim of close to 2 percent.
“The ECB wanted a weaker euro for a while, and while people were accumulating euro-zone stocks and peripheral debt, they weren’t successful in that,” Jens Nordvig, a managing director of currency research at Nomura Holdings Inc. in New York, said July 23 by phone. Nomura, Japan’s largest brokerage, sees the euro at $1.30 by year-end.
Investors pulled $403.3 million from European equity funds in the three weeks ending July 23, the longest streak in more than a year, according to data from EPFR Global in Cambridge, Massachusetts. The benchmark Stoxx Europe 600 Index of equities slipped 2.4 percent since July 3, when it approached a 6 1/2- year high reached a month earlier.
Bond Flows
Flows into European bonds moderated in the second quarter, with investors channeling just over $7.5 billion into the assets, versus about $14 billion in the January through March period, according to EPFR.
Morgan Stanley said some money is still moving into the region’s bonds as European investors mop up assets sold by overseas investors, who are fleeing the continent after the ECB cut its deposit rate to negative last month.
Spanish five-year notes yielded 1.13 percent yesterday, or 0.64 percentage point less than similar-maturity U.S. Treasuries. That’s even with Spain’s ratio of debt to gross domestic product at 94 percent, more than the U.S.’s 72 percent. In July 2012, Spanish five-year yields closed as high as 7.59 percent, while their U.S. peers paid 0.54 percent.
Draghi’s counterpart across the Atlantic, Federal Reserve Chair Janet Yellen, is also helping weaken the euro.
The U.S. central bank chief sent the 18-nation currency tumbling below $1.35 on July 18 for the first time since February after she told Congress that increases in interest rates will probably occur “sooner and be more rapid than currently envisioned” if the labor market keeps improving more quickly than projected.
Hedge Funds
Hedge funds and other large speculators are increasingly turning against the euro.
The difference in the number of wagers on a decline in the euro compared with those on a rally — net shorts — totaled 88,823 contracts on July 22, the most since November 2012, according to the latest data from the Washington-based Commodity Futures Trading Commission.
“The capital-flow dynamics that were very supportive for the currency are now less so,” Richard Franulovich, the chief currency strategist for the northern hemisphere at Westpac Banking Corp. in New York, said by phone on July 23. “There are fewer tailwinds now supporting the currency.”
[Bloomberg]
