Funds Flow Out of Euro

Foreigners sell European equities; central bankers prefer yen, pound.

The euro’s rebound from its weakest levels since January is in jeopardy as banks from UBS AG to Morgan Stanley say they see money flowing out of the currency.

Foreigners were net sellers of European equities in the past five weeks, according to Zurich-based UBS. Morgan Stanley data show that investors have had a net short, or bearish, position in the currency since September. The reports add to International Monetary Fund figures showing a drop in allocations to the euro by central banks since a 2009 peak.

German Chancellor Angela Merkel and French President Nicolas Sarkozy are counting on international support as they seek to resolve the region’s sovereign debt crisis, setting a deadline of the Nov. 3 Group of 20 summit. While the euro has gained 2.7 percent since a Sept. 12 low against nine developed- nation counterparts as measured by Bloomberg Correlation-Weighted Indexes, it’s about 3.8 percent below its high for the year in May.

“The big money, the real money managers, are paring their exposure on a strategic basis,” Samarjit Shankar, a Boston-based managing director of foreign exchange at Bank of New York Mellon Corp., which administers about $26 trillion as the world’s largest custodial bank, said in an Oct. 11 interview. “Non-European fixed-income investors are just calling it a day and pulling out of Europe.”

Equity Flows

The amount of money investors pulled out of the region’s most indebted nations’ bond markets this year as Greece 10-year yields rose above 20 percent was as much as twice the average of 2010, according to Bank of New York Mellon’s “iflow” data, which is used by the IMF and the Bank of Japan in their analyses.

UBS’ equity-flow gauge showed investors cut their holdings of shares in the euro zone in the five weeks through Oct. 7, while it was “broadly flat” for U.S. stocks, analysts at the bank said in an Oct. 10 report.

Instead of euros and dollars, central banks are putting more reserves into Japan, Britain, Australia and Canada, according to Barclays Plc and Citigroup Inc.

Europe’s 17-nation currency traded at $1.3870 at 8:23 a.m. in London, having strengthened 3.8 percent last week to $1.3882. It fell 0.2 percent to 107.04 yen today and climbed 4.4 percent to 107.20 yen in the five days to Oct. 14. The Bloomberg Correlation-Weighted Currency Index for the euro rose to 99.3268 from 98.7399 on Oct. 7.

The median estimate of at least 30 analysts surveyed by Bloomberg is for the euro to weaken to $1.35 by year-end, and depreciate to 104 yen. UBS, the world’s third-largest currency trader, sees it falling to $1.20.

‘Bear-Market Rally’

“We are in the midst of a bear market rally” and the currency should weaken to $1.25 in the first quarter of 2012, Calvin Tse, a foreign exchange strategist at New York-based Morgan Stanley, said in an Oct. 14 interview.

Morgan Stanley’s latest “FX Positioning Tracker,” which uses six proprietary indicators including money flows through the firm and ranges from -10 to 10, was -6 on Oct. 10. It was last neutral, or zero, on Sept. 5.

The euro rallied last week after Merkel and Sarkozy set a three-week deadline to devise a plan to recapitalize the region’s banks and find a “durable” solution for Greece, which is in jeopardy of defaulting. The euro is about 15 percent stronger than its average versus the dollar since January 1999, buoyed in part by their pledges to preserve the monetary union.

Additional Powers

It also gained as Slovakia backed the enhanced European Financial Stability Facility, the rescue fund that will have a lending capacity of 440 billion euros ($609 billion), which is “ready” to use its expanded powers, according to European Commission President Jose Barroso. The EFSF has gained the power to buy sovereign bonds, offer credit lines to governments and grant aid for bank recapitalizations. The fund’s role had been to sell bonds to finance rescue loans.

Europe’s revamped strategy won the backing of global finance chiefs, who urged the region’s leaders to deal “decisively” with the turmoil when they meet for emergency talks in a week’s time.

“The plan has the right elements,” U.S. Treasury Secretary Timothy F. Geithner told reporters in Paris. Bank of Canada Governor Mark Carney said that “some of what is being considered, if fully implemented, would be sufficient in our opinion.”

‘Lot of Progress’

“We’ve actually seen a lot of progress, comments in the right direction showing that they are going to move forward in terms of finding a comprehensive solution,” Mary Nicola, a New York-based foreign exchange strategist at BNP Paribas SA, said in an Oct. 12 interview.

The euro may climb to $1.45 by year-end, she said, as Europe makes progress toward resolving its debt crisis and the Federal Reserve starts to print money again to buy bonds as the economy falters, debasing the greenback, according to Nicola.

At the same time European Union leaders expressed optimism that they can fix Greece, and France and Belgium decided to dismantle Dexia SA, three years after rescuing what was once the world’s largest lender to municipalities, and Standard & Poor’s cut Spain one level to AA- from AA.

Forcing losses on sovereign bondholders as a way to fix the region’s crisis may “damage the reputation of the single currency internationally, possibly adding to volatility in foreign-exchange markets,” the European Central Bank said in its monthly bulletin on Oct. 13. “Public and private international investors may be cautious about investing large portions of their wealth in assets denominated in a currency of sovereigns that may not fully” repay their debts, it said.

Declining Share

The euro’s share of global reserves fell to 26.7 percent as of the end of June from a peak of 27.9 percent in September 2009, a month before Greece’s new government sparked the debt crisis by revealing that its predecessor had understated the budget deficit, IMF data on Sept. 30 showed.

The pound’s share of reserves was little changed at 4.2 percent, and up from 4 percent at the end of last year, while the yen’s rose to 3.9 percent from 3.2 percent. Central banks and other wealth managers raised allocations to a group the IMF calls “other currencies,” which Citigroup says likely includes equal amounts of Australian and Canadian dollars and Swedish krona, to 4.9 percent from 3 percent.

‘More Attractive’

Smaller Group of 10 “currencies are providing a more attractive alternative as they have a much better sovereign- credit situation and much greater exposure toward the fastest growing economies of the world,” Andrew Cox, a strategist at Citigroup in New York, said in an interview on Oct. 11.

Reserve managers reduced their euro holdings by an equivalent of $11 billion in the year through June, adjusting for the currency’s appreciation, according to Citigroup.

Global reserves were $10.1 trillion at the end of June, up from $8.16 trillion at the end of 2009, according to the IMF, which calculates data from central banks that report their currency allocations. Some countries, including China, whose $3.2 trillion in reserves are the world’s largest, don’t give currency breakdowns.

China, the largest foreign lender to the U.S., raised its holdings of Treasuries in July to the highest level in nine months, according to the Treasury Department statistics released Sept. 16. The world’s second-largest economy boosted its U.S. debt securities to $1.17 trillion as China’s trade surplus surged to the highest in more than two years, the data showed.

Crisis to Crisis

While optimism that politicians can agree a plan on banks may push the euro toward $1.40, gains won’t last as the region is “likely to lurch from one crisis to another,” Chris Walker, a strategist at UBS in London, said in an Oct. 12 interview. “It will take a major act of political unison and fundamental change in the system to solve the structural problems for good, something which would likely take time to implement.”

Hedge funds and other large speculators held a net 73,795 contracts at the Chicago Mercantile Exchange as of Oct. 11 betting on a drop in the euro, according to the Washington-based Commodity Futures Trading Commission. In May, there were a net 99,516 contracts wagering on a gain.

“I don’t see anything to be optimistic about in Europe,” John Brynjolfsson, chief investment officer at Aliso Viejo, California, Armored Wolf LLC, said in an Oct. 14 interview with Matt Miller on Bloomberg Television’s “Street Smart.” “The euro is depreciating,” said Brynjolfsson, who oversees about $1 billion. “That is a trade you definitely want to have on.”



Bloomberg News


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