The Euro Emerges as Unlikely Safe Haven

Safe Havens a Moving Target in Central Bank Market
  • Greece a distant memory as euro surges on China rout
  • `Stunning' rally troublesome for ECB inflation targets

The notion that the euro could be a haven in times of turmoil seemed preposterous just a few weeks ago. Yet that’s exactly what it’s become as the world gets rocked by everything from devaluations to bear markets in stocks.

The euro has surged almost 4 percent against a basket of developed-nations peers in the past month, the biggest gain in the group. It’s up against more of the world’s major currencies than the dollar, yen, Swiss franc or pound. And it’s climbing even as the European Central Bank expands the supply of euros.

While the rally signals confidence in the 19-nation currency union following the Greek crisis, it also complicates the ECB’s efforts to jump-start the economy. That’s because a stronger exchange rate has the potential to curb exports and slow inflation.
“Safe-haven flows have been mainly targeted at the euro, which I think is stunning,” said Thu Lan Nguyen, a strategist in Frankfurt at Commerzbank AG. “The ECB won’t just stand aside and may start to try to verbally weaken the currency. That’s their prime instrument for delivering inflation.”

China’s shock devaluation this month sparked a rout in emerging markets that’s prompted investors to unwind carry trades funded in euros. These deals involved borrowing at the ECB’s near-zero interest rates to fund higher-yielding purchases, and canceling them means buying euros back.

QE Turnaround

Growing skepticism that the Federal Reserve will raise interest rates in September is also supporting Europe’s single currency at the expense of the dollar.

The ECB’s quantitative-easing program is even starting to support the euro by reassuring investors there’s demand for European assets. The purchases started out debasing the currency by putting more money into circulation.

“As the euro’s been funding China carry trades, a position wind-up has seen it soar,” said Neil Mellor, a senior foreign-exchange strategist at Bank of New York Mellon Corp. in London. “In the longer run, though, the strong-dollar view will prevail because of the divergent monetary policies.”

Surge Accelerates

The euro rose above $1.17 on Monday for the first time since Jan. 15, when Switzerland abandoned its euro-franc limit. That capped its biggest four-day rally since 2009. The single currency retreated on Tuesday, falling 1.6 percent to $1.1435 at 1:33 p.m. in New York.

It’s up almost 10 percent from a 12-year low reached in March when the currency union seemed in danger of splintering and the ECB started its QE bond purchases. And it touched the strongest level this year in a basket of 10 rich-world peers tracked by Bloomberg Correlation-Weighted Indexes.

That wasn’t in the playbook, either for ECB officials or most currency strategists.

Just three of 69 analysts predicted the euro would climb to its current levels by year-end when they were surveyed at the end of March. While ECB President Mario Draghi has consistently denied using QE to target the exchange rate, he’s acknowledged the economic benefits a weaker euro can bring.

He has a lot of ground to make up. Euro-zone inflation was just 0.2 percent in July, against a target of close to 2 percent, while the economy is forecast by analysts to grow 1.4 percent this year, half the average pace across the Group-of-20 nations.

Longer Term

Draghi may still get some relief from a weaker euro. While strategists have been raising their forecasts since May, they still see it falling versus 14 of its 16 major peers by the end of 2016.

Commerzbank’s Nguyen predicts the euro will decline to $1.06 this year before trading one-for-one with the dollar by the end of next year. Back in March, her bank was predicting $1.04 by Dec. 31.

And while traders are paring bets on the Fed raising rates next month, they’re still assigning about 50 percent odds to an increase at or before its December meeting.

The dwindling chance of an imminent move by the Fed is really what’s driving the euro higher, rather than anything fundamental to Europe that would worry the ECB, according to Petr Krpata of ING Groep NV.

“Euro-dollar strength is largely a function of a weaker dollar,” said the London-based currency strategist. “Given that the ECB’s QE is under way and the market already has a dovish view on the ECB, the euro is more immune to markets re-pricing the global inflation outlook.”

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