Euro Is a Haven and So Much More to TradersBy and
Common currency cements safe harbor status amid market stress
Improving macroeconomic backdrop seen fueling further gains
When the going gets tough, traders are increasingly buying the euro these days.
Europe’s common currency, which just a few years ago was almost a byword for political instability and faced threats to its very existence, is now attracting buyers at times when risk assets around the world are being sold. Part of that is due to haven flows and investors unwinding carry trades. But it also reflects a market that is increasingly upbeat about growth and inflation in Europe even as central bankers remain reticent about dialing back stimulus.
“Europe is becoming an attractive destination to put your money to work,’’ said Viraj Patel, a London-based currency strategist at ING Groep NV. “This is certainly the case for medium-term real money investors, who are more sensitive to broader political trends and cyclical economic stories.”
While investors aren’t pricing any rate hikes by the European Central Bank until at least 2019, strategists say it’s becoming harder to ignore the continent’s improving macroeconomic backdrop when looking at the euro against its peers. With European interest rates still hovering near record lows, the shared currency has yet to decisively break above the key $1.20 level. But behind its recent bouts of strength lies the realization that the ECB may start running out of excuses to maintain its stimulus.
Policy makers may be coming around to that view as well. ECB President Mario Draghi said Friday that wage growth should start to pick up, helping push inflation back toward the central bank’s goal of close to 2 percent. Draghi’s comments followed remarks from executive board member Yves Mersch, who said that markets wouldn’t be right to expect another extension of asset purchases after September 2018.
The euro rallied as global equities took a battering earlier this week and is on track for its strongest weekly gain since Sept. 8. It’s risen more than 1 percent since last Friday and stood at $1.1795 as of 10 a.m. in New York.
The average forecast in a Bloomberg survey of analysts is for the common currency to appreciate to $1.22 next year and $1.25 in 2019. Goldman Sachs Group Inc. predicts that the euro will advance to $1.20 in the coming 12 months and says that the portfolio shifts that have driven strength in the currency this year have “more room to run.”
A surplus in the region’s current account, the broadest measure of trade and services, underpins the euro’s haven appeal, according to Vassili Serebriakov, an FX strategist at Credit Agricole SA. “Overall, the euro does perform fairly well in risk-off environments,” he said.
Increased political stability also helps. Risks posed by events such as this year’s French elections are now largely in the rear-view mirror for Europe, and the market impact of more unexpected disturbances such as the ructions in Catalonia have been relatively muted. That’s a far cry from the kinds of scenes that were playing out across the continent at the height of the euro-zone debt crisis. In contrast, other major currencies such as the dollar and the pound are currently plagued by major political uncertainties in the wake of last year’s U.S. election and the Brexit vote.
Growth and Inflation
The euro’s advance comes as analysts boost expectations for European economic expansion and markets price in firmer prospects for inflation. Analysts surveyed by Bloomberg have raised their median euro-area growth forecasts for this year to 2.2 percent from about 1.5 percent at the beginning of January. Last week’s better-than-expected German gross domestic product figures underscored the strength of a European economy that’s on track for its best year of growth in a decade and provided extra impetus for euro bulls.
And while price growth remains short of the European Central Bank’s 2 percent goal, the five-year, five-year inflation swap rate rose to the highest level since March this week as policy makers continue to advocate prudence in scaling back ultra-expansionary monetary stimulus.
Investors calling time on emerging market carry trades, among the most profitable currency strategies this year, will also fuel a year-end boost for 19-nation currency as traders reassess positions, according to Credit Agricole’s Serebriakov.
“We’re approaching year-end, and carry trades in the emerging-market space have been very popular this year, so we’re seeing a bit of positioning unwind,” he said.
Europe’s burgeoning current account surplus and persistent growth will sustain euro strength into 2018, according to Shahab Jalinoos, head of foreign-exchange strategy at Credit Suisse Group AG. The surplus expanded to a record 3.5 percent of GDP in June 2016, from about zero in 2011, according to data compiled by Bloomberg. The surplus remained at 3 percent as of June.
“The euro will continue to go higher because of the 3 percent of GDP current account surplus backing it up,” Jalinoos said in a Bloomberg TV interview. “Effectively, when you combine that with the very strong growth number that we’ve seen in countries across the euro area, the natural path is to go up.”
— With assistance by Ye Xie, Edward Bolingbroke, and Alexandria Arnold