The euro is becoming a haven for investors who just three years ago pushed the 17-nation currency union close to breakup.
The 90-day correlation between changes in the euro and a Citigroup Inc. index of bond and swaps risk has turned positive for the first time since November 2008, meaning the currency is gaining favor as investors’ perceptions of turmoil in financial markets rises. Hedge funds and other large speculators are the most bullish on the euro since 2011, data from the U.S. Commodity Futures Trading Commission show.
While European Central Bank President Mario Draghi said yesterday that risks for euro-area growth remain on the “downside” and the euro fell to a six-week low against the dollar, investors are taking comfort from the region emerging from its longest recession and a sovereign-debt crisis. That’s making the euro a refuge for traders fleeing emerging-market nations missing out on a global recovery.
“The euro remains resilient and repatriation from emerging markets is playing an important role,” Valentin Marinov, the London-based head of Europe Group of 10 foreign-exchange strategy at Citigroup, the second-biggest currency trader, said in a Sept. 2 phone interview. “It could continue to play a safe-haven role as a liquid reserve currency, so long as tail risks of the euro-zone breakup are held at bay.”
The correlation between the euro and Citigroup’s risk index, which tracks emerging-market bond and U.S. credit and swaps spreads, was at 0.0687, after reaching 0.107 on Aug. 23, according to data compiled by Bloomberg. That was the most positive relationship since October 2008, when the collapse of Lehman Brothers Holdings Inc. was roiling markets.
The relationship turned positive Aug. 22, meaning that the euro is now strengthening as the risk gauge increases. The Australian dollar’s link with the index was minus 0.131 yesterday, meaning the currency typically declines when the Citigroup index increases.
The euro will end the year around current levels, according to Citigroup’s Marinov, making him more optimistic than the median forecast in a Bloomberg survey of analysts, which has the currency falling to $1.28.
The shared currency fell as much as 0.7 percent yesterday to $1.3111, the lowest level since July 19, and was little changed today at $1.3130 as of 10:01 a.m. in London. It will depreciate to $1.30 by June 2014, Marinov said, compared with a $1.26 median estimate.
Over the past six months, the euro has strengthened against all but three of 31 major peers tracked by Bloomberg, gaining more than 20 percent against India’s rupee and Indonesia’s rupiah, and about 19 percent versus the Brazilian real. It advanced against all major emerging-market currencies except the Chinese yuan and Bulgarian lev in that period.
The declines in currencies of nations viewed by investors as higher risk accelerated on May 22, when Federal Reserve Chairman Ben S. Bernanke signaled that the central bank may begin tapering the pace of asset purchases at one of its “next few meetings.” The rout picked up last month as the U.S. weighed striking Syria amid allegations of a chemical weapons attack by the Middle East nation’s government.
More than $47 billion has left global funds investing in emerging-market bonds and stocks since May, extending the outflow this year to $7.5 billion, according to data last month from EPFR Global. Outflows in the week through Aug. 28 were the highest in two months, with record withdrawals being recorded for Mexico and Philippine equity funds, EPFR said Aug. 30.
“The euro is perceived as a safe haven in the current environment, where we’re not in a G-10 crisis, but an emerging-market one,” Sebastien Galy, a senior currency strategist at Societe Generale SA in New York, said in a Sept. 3 phone interview. “People who were very, very negative on the euro zone were very, very wrong on that. These people have now changed their mindsets.”
While the euro has fallen more than 2 percent versus the dollar since reaching a six-month high of $1.3452 on Aug. 20, it has remained within its past-year’s trading range of $1.2502 to $1.3711, data compiled by Bloomberg show. That’s up from as low as $1.1877 in June 2010, when the euro sovereign-debt crisis was deepening, and compares with $1.2043 last July, before Draghi said he’d do “whatever it takes” to save the shared currency.
Draghi’s pledge led to a bond-buying program called Outright Monetary Transactions that, while it hasn’t been used, helped drive Spanish 10-year yields down from euro-era highs of 7.75 percent and contained a sovereign-debt crisis that began more than two years earlier with the region’s most indebted nations, such as Greece and Ireland, needing bailouts. Spain’s 10-year bond yield has since fallen to 4.56 percent.
The yield on 10-year bonds of Italy, considered one of the continent’s riskier nations, has fallen to 4.53 percent on optimism that the trading bloc has sidestepped a breakup, from as high as 7.48 percent in November 2011. The yield reached as low as 3.20 percent in September 2005, almost two years before the U.S. subprime-mortgage crisis triggered the worldwide financial meltdown.
The euro climbed 5 percent against a basket of nine developed-nation peers this year, the biggest gain after the dollar, which rose 5.6 percent, according to Bloomberg Correlation-Weighted Indexes.
Futures contracts signal more gains for the euro. The difference in the number of wagers by large speculators on an advance in the currency compared with those on a decline -- or net longs -- rose to 40,081 on Aug. 27, the most since July 2011, the latest data from the Washington-based CFTC show. Net short positions reached a record 214,000 in June 2012.
The ECB left its main refinancing rate at a record-low 0.5 percent yesterday for a fourth month, in a decision predicted by all 47 economists in a Bloomberg News survey.
“The overall improvements in financial markets seen since last summer appear to be working their way through to the real economy,” Draghi said at a press conference in Frankfurt. The euro area is recovering “at a slow pace” and ECB policy will “remain accommodative for as long as necessary,” he said.
While the currency’s resilience reflects confidence in Draghi’s efforts to safeguard the euro-area’s future, an overvalued currency risks making exports less competitive, endangering the recovery.
The region’s economy expanded 0.3 percent in the second quarter, in line with a previous estimate, the European Union’s statistics office said Sept. 4. Exports rose a seasonally adjusted 3 percent in June, the first increase in three months, the EU said Aug. 16.
Spain and Greece remain in recession, and the currency bloc is grappling with a record 12.1 percent unemployment rate. While Germany’s economy will grow 0.5 percent over this year, the euro area will shrink 0.6 percent, according to Bloomberg economist surveys. The U.S. is estimated to expand 1.6 percent.
“While Germany might be showing some positive signs, we’ve still got these horrific numbers elsewhere in peripheral Europe,” Simon Derrick, the chief currency strategist at Bank of New York Mellon Corp. in London, said in a Sept. 3 phone interview. “So the likelihood that you’re going to have markets that outperform,” starts “to dwindle.”
The euro may decline to about $1.25 this year if the Fed sticks with its timetable for tapering stimulus and investors start pricing in higher interest rates, Derrick said.
Even as some traders bet that the euro would fail to survive, its share of $11.1 trillion of worldwide currency reserves remained above levels immediately after the 1999 debut, International Monetary Fund data show. The euro’s proportion was 24 percent this March, from 28 percent in September 2009 and as low as 17 percent in September 2000.
The euro is the most widely traded currency after the dollar, according to the Bank for International Settlements. Europe’s shared currency accounted for 33 percent of the $5.3 trillion average daily turnover in foreign-exchange markets in April, compared with 87 percent for the greenback, the BIS said in a report yesterday. Given that foreign-exchange trades involve two currencies, the sum total of percentage turnover as measured by the BIS is 200 percent.
“It’s difficult to find something negative for the euro at the moment, or at least not anything that’s in focus,” Niels Christensen, the chief currency strategist at Nordea Bank AB in Copenhagen said in a Sept. 4 phone interview. “When there’s more optimism about the economy,” then “suddenly there’s a positive spiral for the euro.”