Euro starting to act like a high-yielder, a good omen for stocks

LONDON -Eurozone interest rates still lag those in many other major economies but the euro is increasingly acting like a high-yielder, a darling of carry traders. The currency hit an all-time high on Thursday against both the Japanese yen and Swiss franc in yet more evidence that the carry trade is alive and well after last month’s market whiplashings. The low-yielding yen and franc are the bedrock of the carry trade, in which investors borrow cheaply to invest in higher-yielding assets elsewhere. The Australian dollar, which hit a decade high against the yen, the British pound, New Zealand dollar and emerging market currencies like the South African are all favored targets. But despite yielding a fair bit less than all these currencies, the euro is now behaving as if it has joined them. «It is moving towards that,» said Thanos Papasavvas, head of currency management at Investec Asset Management. «It is basically the currency where we see continuing rate rises.» In purely nominal terms the eurozone is by no means in the high-yielding camp. The European Central Bank left rates on hold on Thursday at 3.75 percent. By contrast, Britain is at 5.25 percent, Australia at 6.25 percent and New Zealand at 7.50 percent, while South Africa left rates at 9.0 percent. The key, however, is that the ECB is on a clear tightening campaign. A hike to 4.0 percent in June at the latest is priced into the market and Papasavvas reckons that while there could be a pause after that the big issue then will be when, not if, the next hike comes. US fund firm Putnam Investments, meanwhile, reckons ECB rates have already risen high enough to wipe out any advantage the US Federal Reserve’s 5.25 percent might give the dollar. «Interest rate spreads have narrowed to below key threshold levels versus Europe,» it said in its latest outlook. Booming Europe The strength of the euro, of course, is not solely due to interest rates. Some analysts see it, rather, as a reflection of US dollar bearishness. The eurozone economy is moving ahead strongly and European stocks are climbing while US growth slows and Wall Street plods along, relatively speaking. The European Commission confirmed on Thursday that full-year growth in 2006 came to 2.7 percent unadjusted for working days, the fastest annual expansion since 2000 and almost double the 1.4 percent logged in 2005. «Euroland is clearly growing above potential, the US is growing below trend,» said Paresh Upadhyaya, a senior vice president in Putnam’s currency team. He added that central banks were also boosting the euro by diversifying reserves. All this has made many investors overweight the euro, which has gained around 2 percent on the dollar so far this year and is only around 1.5 cents off its all-time high. But the euro’s strength against the yen and Swiss franc would also argue for it becoming a carry trade target. «Depending on what currency you look at it does look like a a carry currency,» Upadhyaya said. And while much of carry trade cash ends up in currency forwards, a lot of it from hedge funds and bank proprietary trading desks also flows into other assets. So a euro acting like a high-yielder could bode well for more European stock market gains.

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