Shorting the Euro Is an Outdated Strategy
Michael Hasenstab, the star bond investor, says he’s betting against the euro as a “hedge against populism.” This, however, is a narrative that’s going out of fashion; it won’t define the euro’s performance this year.
In the summer of 2014, Hasenstab defended his Templeton Global Bond Fund’s investment in Ukrainian bonds by saying, “What we liked was that everyone was just looking at some of the noisy headlines and not going to the country and understanding the underlying fundamentals, and we think long-term it’s a good investment opportunity.” The next year, Ukraine forced investors to accept a 20 percent haircut on the bonds. Hasenstab, who had refused to bend to pressure in restructuring talks, probably didn’t lose anything -- he’d bought the bonds at 80 percent of face value, anyway. But he’d misread Ukraine’s economics and politics, as well as Russia’s determination to mess up the neighboring country regardless of the cost. The “noisy headlines” proved correct.
This time around, the noise -- especially in English-language media, alarmed by Brexit and Donald Trump’s election -- has all been about a global populist takeover. Besides, Hasenstab, who invested in Hungarian and Polish bonds, has probably heard a lot about the doings of populist governments in these two European countries. Now, his fund is not just short the euro -- it’s dumped almost all its European investments, a strategy that makes sense if you believe the EU and the euro are doomed, or at least destined for major shocks. Contrary to his advice from three years ago, the bond guru has gone with the headlines.
They are, however, about to change. Predictions of a populist revolution were mostly driven by a deep distrust in the polls, sowed by the U.K. and U.S. upsets. Wednesday’s Dutch election, however, has shown that European polls can still be accurate, even slightly overestimating the chances of a populist triumph. The euro, predictably, is up.
If French polls also live up to their reputation for accuracy and Marine Le Pen suffers a resounding second-round defeat in France’s presidential election, the common currency will probably get a more serious bounce, given France’s relatively higher importance for the euro’s success. The headlines will certainly be bolder. And the likely underperformance of German populists, the AfD, in the September election, might seal a successful political year for the European Union and the euro zone in particular.
Add to this a new trend in “noisy headlines” about the European Central Bank, which is signaling it won’t go for any more monetary expansion because the risk of deflation is gone. Speculation about interest rate increases -- which Germany will be eager to fuel ahead of the election to calm savers tired of zero-to-negative rates -- will tend to strengthen the euro, too.
In a market driven by politicized narratives, there aren’t many potential adverse surprises for the euro this year, provided Le Pen loses as the polls predict. Even more trouble in Greece, leading to an early election, could only be positive, since New Democracy, a docile centrist party that in the past did its best to comply with EU dictates, has opened a wide lead in the polls and radicals are in retreat. At worst, the Greek debt problem will just be kicked further down the road.
Fundamentally, too, the euro zone isn’t as fragile as many English-speaking commentators have suggested. Pro-euro sentiment is stable in the currency area's biggest countries, and even in Italy, with its troubled banking system and a stubbornly stagnating economy, a majority still believes in the single currency; in France, even were Le Pen to win and call a referendum on euro-zone membership, voters likely wouldn’t back her.
Economic fundamentals aren’t bad, either. The Bloomberg consensus forecast predicts 1.6 percent growth for the euro area, just about in line with last year’s rate, as well as another drop in unemployment, which is already at the lowest level since 2009. The euro’s share in nations’ international reserves appears to have stabilized at 20 percent after falling steeply from about a quarter in 2014.
The refugee crisis has abated, and even if northern European nations’ spat with Turkey means the end of a shaky deal that has stopped many asylum seekers from sailing to Europe from Turkish shores, most countries along the major migration routes have already strengthened their borders. The danger of terror attacks remains -- but here, too, European nations have scrambled to enhance security, investing in bigger police forces and learning to be vigilant where it matters.
For all the talk of a Europe in crisis, the EU and the euro area are holding up quite well under stress. They could do even better if member states could formulate a new strategy for the union -- but perhaps no organization this big and diverse could do this immediately after a series of major stress tests.
So far, investors don’t appear to have taken the potential for European resurgence fully on board. They are collectively short the euro.
But if these short positions were justified in 2015 -- when Hasenstab was also betting against the euro along with most of his peers -- in 2017, they look like a residual overreaction to threats that have, as it sometimes happens in Europe, shrunk somewhat from attrition. It will probably take a stronger positive shift in headlines for the market’s net bet to turn positive, but the collective short position has already shrunk to levels not seen since 2014. If the trend continues, Hasenstab’s bet will soon be a contrarian one.
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