Euro Weakness Waning as Draghi Cash Prompts Forecasters to Drop Bear Views
The world’s biggest banks are less pessimistic about the euro as the European Central Bank provides unlimited cash to the region’s financial system, Germany may avoid recession and Greece looks to complete the biggest sovereign debt restructuring in history.
Strategists at Bank of America Corp. and Morgan Stanley raised their estimates for the euro this month, as the median estimates of more than 50 strategists surveyed by Bloomberg increased for the second and third quarters. The 17-nation currency is up about 1.3 percent from an almost 10-year low on Jan. 16 against nine developed-market peers.
While the crisis that led to bailouts of Greece, Portugal and Ireland and the restructuring of Greek debt caused the euro to weaken 8.7 percent versus the dollar since August, traders who predicted a breakup of the single currency are being silenced. ECB President Mario Draghi gave banks more than 1 trillion euros ($1.31 trillion) of three-year loans in December and February, and German business confidence rose to a seven- month high.
“We’ve been gradually feeling better about Europe,” David Woo, the global head of rates and currencies at Bank of America Merrill Lynch in New York, said in a telephone interview on March 2. Draghi’s loans have supported the euro, he said. “That combined with the fact that the global economic outlook has improved, including U.S. growth gaining momentum, has made us less bearish on the euro.”
Bank of America increased its June 30 call to $1.30 from $1.25, according to a Feb. 29 note.
The euro depreciated 0.6 percent last week to $1.3123 and is 8.8 percent higher than the average of about $1.2067 since its inception in January 1999. It strengthened 0.2 percent to 108.22 yen, taking its year-to-date advance to 8.6 percent against Japan’s currency.
The euro appreciated 0.2 percent to $1.3145 at 1:29 p.m. New York time. It rose 0.1 percent to 108.10 yen.
Draghi cut the ECB’s benchmark interest rate twice, to 1 percent, and expanded the central bank’s balance sheet to more than 3 trillion euros since assuming office Nov. 1, reversing the strategy of predecessor Jean-Claude Trichet, who oversaw 0.25 percentage-point rate increases in April and July.
The measures fueled a rally in Europe’s markets as lenders used cash borrowed under the ECB’s longer-term refinancing operations, or LTROs, to buy higher-yielding assets. Italian two-year note yields have dropped more than six percentage points from a euro-era peak 8.12 percent in November, and similar-maturity Spanish notes have declined more than 3.5 percentage points from 6.12 percent the same month.
The ECB’s three-year loans have been an “unquestionable success” in unlocking credit markets, Draghi said on March 8, after policy makers kept their main borrowing rate at 1 percent. “We are observing a significant inflow, a return of interest, of confidence in the euro.”
Europe’s common currency jumped 1 percent versus the dollar on March 8 as a report showed German industrial output rose more than economists forecast in January. German exports increased 2.3 percent in January, a March 9 report from the Federal Statistics Office in Wiesbaden showed. The Munich-based Ifo institute said on Feb. 23 that its business climate index climbed to 109.6 last month, the highest reading since July.
Predictions of Demise
Predictions of the euro’s demise have waned. “We had a completely irrational market panic at the end of last year, where many people were talking about a breakup of the currency bloc,” Holger Schmieding, chief economist at Berenberg Bank in London, said in a telephone interview on March 9. “Thanks to the ECB, markets are now returning to a semblance of calm and the breakup sentiment is diminishing.”
It will probably trade at $1.34 by the end of June, according to John Normand, London-based head of global currency strategy at JPMorgan Chase & Co., the biggest U.S. lender.
“The ECB’s balance-sheet expansion has been overwhelmingly focused on relieving credit stress, and has had fewer negative impacts in terms of reducing short-term interest rates and raising inflation expectations,” Normand said in an interview on March 9. “That’s why the euro is remaining stable.”
Strategists at Morgan Stanley said March 2 they expect the euro to trade at $1.34 at the end of the quarter, up from a $1.27 forecast a month earlier. They also boosted their estimate for Sept. 30 to $1.24 from $1.18.
“We now believe the ECB will not be quite as aggressive with its policy response and we are not likely to see as deep rate cuts as we were expecting before,” Ian Stannard, head of European foreign-exchange strategy at the bank in London, said in a telephone interview on March. 6. “It looks as if the need for the ECB to take further measures has been reduced and that should allow the euro’s decline to unfold at a slower pace.”
Morgan Stanley now expects a 25 basis-point rate cut this year, coming in the second quarter, compared with a prior forecast for a 50 basis-point reduction in 2012. The firm predicts the euro will slide to $1.19 by year-end.
Its resilience has surprised some of the largest investors in the more than $4 trillion-a-day market. John Taylor, founder of currency hedge fund FX Concepts LLC, predicted in January 2011 that the euro would fall to parity, and still says it will get there eventually, sliding to between $1.15 and $1.18 by May.
“The euro has reason to go down now more so than ever,” he said in a telephone interview on March 9. “This Greek debt deal does nothing other than show that you could lose a lot of money investing in those bonds. Spanish bonds are looking awful. This is just another one of these pauses for the euro. The only question is how long does that pause last.”
Even as the outlook has improved, forecasters say there are more declines to come. The euro will end the second quarter at $1.28 and $1.29 by the conclusion of the third quarter, Bloomberg surveys of economists show. While both are up by one cent since February, the euro will be at $1.29 at the end of the first quarter in 2013, according to another median forecast.
Low rates and the bank loans are prompting traders to sell the euro to fund purchases of higher-yielding assets. The carry trade of borrowing in euros to buy the currencies of Mexico, Brazil, Norway and Australia returned about 31 percent on an annualized basis from the day before the ECB’s second three-year LTRO on Feb. 29 through March 9. The strategy was little changed in 2011.
The euro-area economy may contract by 0.4 percent this year, with recessions in countries including Greece and Italy. Germany will probably grow by 0.6 percent, and 1.5 percent in 2013, according to median predictions of economists in Bloomberg surveys. U.S. gross domestic product will expand by 2.2 percent this year and by 2.5 percent in 2013, surveys show.
“If you look at which economy is relatively stronger, it would have to be the U.S.,” Frances Hudson, who helps manage about $237 billion as a global strategist in Edinburgh at Standard Life Investments, Scotland’s second-biggest biggest money manager, said in a March 6 telephone interview. “We are very heavy the dollar and light the euro.”
U.S. employers boosted payrolls by 227,000 in February, while the unemployment rate stayed at 8.3 percent, the Labor Department said March 9. Job growth over the last six months was the strongest since 2006.
The euro’s advance contrasts with the dollar’s decline after $2.3 trillion in debt purchases by the Federal Reserve from 2008 to June 2011. The IntercontinentalExchange Inc.’s Dollar Index (DXY), which tracks the U.S. currency against those of six trading partners, is down 11 percent to 79.959 from 89.624 in March 2009, its peak since the bankruptcy of Lehman Brothers Holdings Inc. in September 2008.
A Fed pledge to keep rates at about zero through 2014 is weakening the dollar the most of any major currency this year except the yen.
“The Fed’s strong commitment to very easy policy until 2014, that’s certainly a factor that’s bearish for the dollar,” Steven Saywell, head of foreign-exchange strategy for Europe in London at BNP Paribas SA, said in a telephone interview on March 8. BNP Paribas forecasts the euro will end the third quarter at $1.40.
Hedge funds and other large speculators have reduced wagers that the common currency will slide. The so-called net short position was 116,473 contracts as of March 6, from 171,347 in January, statistics from the Washington-based Commodity Futures Trading Commission show.
Draghi’s actions have reduced a measure of European banks’ reluctance to lend. The Euribor-OIS spread, the difference between the euro interbank offered rate and overnight indexed swaps, was 54.7 basis points at the end of last week, data compiled by Bloomberg show. That’s down from 101 basis points in December, the most since the sovereign crisis began.
“The expectation of a doomsday scenario in the euro region has passed,” Pierre Lequeux, head of currency management in London at Aviva Investors, which manages about $424 billion, said in a telephone interview on March 6. “The ECB has been fantastic, liquidity is on tap for banks and that’s a good thing for confidence. The global scenario is also a bit less gloomy than it was six months ago. There are reasons to be positive on the euro.”
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