Euro Calm Lures Investors

The U.S. government shutdown, debt-ceiling debate, and threat of similar future dramas are increasing the euro's appeal to investors, relative to the dollar.

The euro is staking its claim as an alternative to the dollar on concern that the world’s largest economy is destined to suffer fiscal upheavals every few months.

Europe’s common currency, which as recently as July 2012 was in jeopardy of breaking up as the region’s sovereign-debt crisis heated up, is increasingly acting like a haven. It’s this year’s best performer among a basket of 10 developed-market currencies, and its correlation to the 20 most-traded emerging-market currencies has tumbled more than 40 percent, to the lowest level since 2003, data compiled by Bloomberg show.

President Barack Obama said the 16-day federal government shutdown in the U.S. this month “inflicted completely unnecessary damage” on the economy, while a last-minute deal in Congress to temporarily lift the debt ceiling concentrated attention on the next fiscal hurdle in December. The 17-nation euro area, which includes Greece, looks calm by comparison.

“The euro certainly has some appeal, and we’re slightly long,” Adnan Akant, the New York-based chief investment officer for foreign exchange at Fischer Francis Trees & Watts Inc., which oversees $56 billion, said in an Oct. 18 phone interview. “U.S. investors are now pouring money into global assets, selling dollars.”

The euro climbed to $1.3704 on Oct. 18, approaching this year’s high of $1.3711 in February, which was the strongest level since November 2011. It has rallied about 7 percent from an almost five-month low of $1.2746 reached in April, and was at $1.3670 as of 12:07 p.m. in New York.

It advanced 5.8 percent against a basket of nine developed-market peers this year, the best performance in the group and compared with the dollar’s 1.7 percent gain, Bloomberg Correlation-Weighted Indexes show. The euro dropped each calendar year from 2009 to 2012, plunging 20 percent.

The euro’s correlation with a Bloomberg index of emerging-market currencies fell to 0.34 on Oct. 15, the lowest since May 2003. A reading of 1 means they’re in lockstep and minus 1 means they move in opposite directions. The correlation between IntercontinentalExchange Inc.’s Dollar Index to the same basket has risen to its highest level of the year.

The dollar remains the global reserve currency, representing 62 percent of holdings at the end of the second quarter, according to the International Monetary Fund. The euro amounted to 24 percent of the total for the same period.

 

‘Significant Improvements’

As recently as October 2011, the currency bloc was running a deficit in its current account, the broadest measure of trade because it includes investments. On Oct. 17, the same day that U.S. borrowing authority was due to expire, the euro region posted a surplus of 17.4 billion euros ($23.8 billion) for August, up from 15.5 billion euros the previous month.

“We’ve seen very significant improvements in the current account, which is very encouraging,” Steve Barrow, the head of Group of 10 research at Standard Bank Plc, said in an Oct. 16 interview in London with Bloomberg’s Niki O’Callaghan. “Looking at both trade and portfolio flows, you have to say the euro’s in a much stronger position.”

Barrow predicts the euro will advance to $1.40 in the next one to two months.

The European Central Bank has boosted confidence in the euro by offering to buy indebted member states’ debt, though it hasn’t yet had to implement the program, sidestepping the currency-depreciating money printing policies of the Federal Reserve and Bank of Japan.

The euro area emerged from a record-long recession this year, with the economy growing 0.3 percent in the second quarter, the European Union said Sept. 4.

Bonds sold by the euro region’s most-indebted peripheral nations have become safer buys as volatility in Spanish and Italian debt fell in September below that of U.S. Treasuries, according to Citigroup Inc. That’s the first time the volatilities crossed since early 2011, the world’s second-largest currency trader said.

“The volatility difference has adjusted the risk-reward dynamic between Treasuries and euro-area peripherals, which is why capital is flowing into European fixed-income, supporting euro-dollar,” Richard Cochinos, the head of Americas G-10 foreign-exchange strategy at Citigroup in New York, said in an Oct. 10 phone interview. He still predicts the euro will depreciate to $1.33 by year-end.

 

Cutting Growth

Investors’ optimism about the euro area contrasts with concern that U.S. lawmakers will fail to reach a deal as the next fiscal impasse approaches. Last week’s accord sets a Dec. 13 date for completing budget talks that opened Oct. 17. It funds the government through Jan. 15 and suspends the debt limit through Feb. 7.

“There are only so many times we can do this without the wolf really being at the door,” Senator Mark Warner, a Virginia Democrat, told Bloomberg Television on Oct. 16. “This is not a responsible way to run the largest enterprise in the world.”

Standard & Poor’s said last week the shutdown shaved at least 0.6 percent from economic growth this quarter.

The Bloomberg U.S. Dollar Index, which tracks the greenback against 10 major currencies, fell about 1 percent since the Oct. 16 congressional deal was reached. The dollar gauge dropped to an eight-month low of 1,000.70 in New York on Oct. 18, from 1,056.33 in July, data compiled by Bloomberg show.

The fiscal crisis stoked speculation the Fed will delay trimming the $85 billion it prints every month pump into the through its bond purchases. No reduction will happen until March, according to the median of 40 responses in a Bloomberg News survey of economists.

Strategists are capitulating on bearish euro calls, with the median of more than 65 estimates in a Bloomberg survey seeing the currency ending this year at $1.32. The median forecast was $1.26 on Aug. 1.

“Markets are already long-euro, which is limiting the possibility of the currency gaining further,” Daniel Katzive, head of North America foreign-exchange strategy at BNP Paribas SA in New York, said in an Oct. 15 phone interview. “If we do get into an environment where markets get much more risk-averse, long positions could be collapsed in a period of stress.”

European bond funds attracted $796 million, a 22-week high, for the period ended Oct. 9, according to data published by EPFR Global. Emerging-market debt funds suffered outflows for 17 straight weeks before the streak ended in late September, the data provider said on Oct. 11.

“There could be significantly more flows going into the euro zone,” Peter Kinsella, a senior currency strategist at Commerzbank AG in London, said in an Oct. 15 phone interview. “There’s an argument for value investors to get involved in the European story there.”

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