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Euro Path Set as Lower Rates Invigorate Carry Traders
Started:September 5th, 2014 (08:37 PM) by kbit Views / Replies:110 / 0
Last Reply:September 5th, 2014 (08:37 PM) Attachments:0

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Euro Path Set as Lower Rates Invigorate Carry Traders

Old September 5th, 2014, 08:37 PM   #1 (permalink)
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Euro Path Set as Lower Rates Invigorate Carry Traders

The euro, even after falling to its lowest levels since mid-2013 following the European Central Bank’s interest-rate cuts yesterday, is poised to get even weaker based on differences in global borrowing costs.

Record-low rates in the euro zone will probably encourage traders to borrow in the region and invest the proceeds in economies with higher-yielding assets. All except one of the 44 potential carry trades funded in euros tracked by Bloomberg made money yesterday after ECB President Mario Draghi pushed the deposit rate further below zero, and said he would expand the money supply by purchasing asset-backed securities.

The latest decision by the ECB “cements the euro’s position as a funding currency,” Valentin Marinov, Citigroup Inc.’s London-based head of European Group of 10 currency strategy, said by phone yesterday. “What’s important is that the ECB is the first major central bank which is not only pumping money into the economy, but also penalizing banks for holding it. That means they will have to buy other assets, meaning some of the cash will leave the euro zone in euro-funded carry trades.”

Citigroup is joined by Pioneer Investment Management Inc. in recommending trades in which investors sell the euro to buy currencies of nations with higher rates. Jens Nordvig, a managing director of currency research at Nomura Holdings Inc., trimmed his forecast for the euro to $1.27 by month-end.
Deflation Fight

The currency was at $1.2943 at 8:15 a.m. London time, after dropping to $1.2920 yesterday, the lowest since July 2013. The currency is set for an eighth week of declines, the longest since it began trading in 1999.

The 18-nation currency tumbled 1 percent yesterday versus a basket of the dollar, yen, pound and six other major currencies as measured by Bloomberg Correlation-Weighted Indexes, the biggest decline since May 2011. The euro gauge fell to 98.9301, the lowest since July 2013, and was at 99.125 today.

A weaker euro may be welcome for Draghi, who has signaled the need for a lower exchange rate to help stave off deflation and make the region more competitive. The euro-area inflation rate languished at 0.3 percent last month, a fraction of the ECB’s 2 percent goal. The ECB said yesterday it expects gross domestic product to expand by 0.9 percent this year, below its previous forecast of 1 percent.
‘Funding Currency’

“The ECB solidified the euro’s status as a funding currency, perhaps making it even more attractive than the yen because deposit rates are negative,” Paresh Upadhyaya, the Boston-based director of currency strategy at Pioneer Investment, which oversees $248 billion, said in a telephone interview yesterday. “People had a few choices coming into September, either ride the dollar trend, or to go the other way. Given the fundamental backdrops, it looks like currency investors are riding the rally.”

The euro tumbled 1.4 percent last month against the basket of nine developed-market peers, the most since it fell 1.7 percent in March 2013, after Draghi said during an Aug. 22 symposium of central bankers in Jackson Hole, Wyoming, that policy makers are prepared to add more monetary stimulus.

While Draghi’s first job as ECB president after taking over in November 2011 was to stop the region’s debt crisis from splintering the currency bloc, his focus has switched to preventing a slide into deflation. The Italian economist committed to buying asset-backed securities and covered bonds with the intention of funneling cash into an economy that stalled last quarter and where lending has shrunk for more than two years.
Higher Yielding

“While Draghi continues to show his progressive intent, the specific economic impact of the measures he has announced is likely to have less impact than will be delivered by the euro’s reaction to his policy initiatives,” Gregor Macintosh, head of sovereign, emerging debt and foreign exchange at Lombard Odier Investment Managers in Geneva, wrote in a note yesterday.

Lombard Odier is short on the euro, or betting on further declines, and considers emerging-markets to be attractive versus the currency.

The euro fell 1.8 percent against India’s rupee and 1.7 percent versus the Malaysian ringgit yesterday. In carry trades, a decline in the funding currency or an increase in the target exchange rate adds to the return from the rate differential. India’s central-bank rate is 8 percent.

Carry Trade

The carry trade is providing some solace for traders in the $5.3 trillion-a-day foreign-exchange market, who have seen returns squeezed by falling volatility. While UBS AG’s V24 Carry Index has climbed more than 7 percent in 2014 and is set for its best year since 2009, the Deutsche Bank Currency Returns Index, which monitors gains by replicating trading strategies based on carry, momentum and valuation, is down on the year.

Draghi said yesterday the aim of all the ECB measures combined is to return the central bank’s balance sheet to the level it was at the start of 2012. The ECB had about 2.7 trillion euros of assets then, when the euro traded as low as $1.2624, compared with 2.04 trillion euros now.

“The biggest takeaway is they want to bring the balance sheet back to 2012 level,” David Woo, head of global rates and currencies in New York at Bank of America Corp.’s Merrill Lynch unit, said in a phone interview yesterday. “We’ve been forecasting $1.30 year-end. Right now, anything is possible. The risk is to the downside of our forecast.”
BOJ Meeting

The Fed’s assets total is $4.42 trillion, widening the difference with the ECB’s balance sheet to a record $1.8 trillion. The Bank of Japan finished its meeting yesterday by maintaining its record debt purchases of 60 trillion yen ($570 billion) to 70 trillion yen a year.

“The euro and the yen are both very attractive as funding currencies, and the dollar has really dropped out of that category,” Daniel Katzive, a director and head of foreign-exchange strategy, North America, at BNP Paribas SA in New York, said in a phone interview yesterday. “With U.S. data continuing to surprise on the upside this week, the combination is very powerfully negative for euro-dollar. We think the euro has a lot further to fall.”

Euro Path Set as Lower Rates Invigorate Carry Traders - Businessweek

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