As Central Banks Mull Pullback
of Easy Money, Investors Turn to Relatively Stable European Currency
By MATTHEW
WALTER and NICOLE
HONG
The euro is emerging as an
unlikely oasis in the latest bout of market turmoil.
Assets ranging from Japanese
stocks to emerging-market bonds to U.S. Treasurys have slumped this spring, as
investors brace for the possible pullback from easy-money policies by the
world's major central banks. But the euro has largely avoided the volatile
trading that has whipsawed other currencies, including the dollar and the
Japanese yen, gaining about 4% against the greenback over the past four weeks
to trade late Friday at $1.3345, near a four-month high.
It is a dramatic reversal for
a currency that frequently has been at the center of global market turmoil in
the past few years. Investors had put on record bets that the euro would fall,
fueled by Europe's economic slump and questions about the long-term viability
of the currency union.
Bearish euro positions have
tumbled 90% in the past two weeks, according to the Commodity Futures Trading
Commission. Despite problems that include stunted European economic growth,
rising unemployment and large debt loads in southern European economies, many
investors say the euro is a relatively safe bet these days, thanks to its
status as a heavily traded reserve currency and ebbing fears of an imminent
crisis.
The prospect of an early end
to Federal Reserve stimulus has prompted many traders to hastily unwind bets on
emerging markets and other high-yielding assets. As these positions unravel,
some investors are taking shelter in the euro, which they see as having more in
common with havens such as the dollar and yen than riskier, more thinly traded,
higher-yielding currencies like the Australian dollar.
"It's hard to bet against
the euro," said Sam Katzman, chief investment officer for New York-based
Constellation Wealth Advisors, which invests about $5 billion in various funds
on behalf of clients. "Until we stop printing money in the U.S., or they
start, the wind is at the back of the euro."
Driving the euro's strength is
an unwinding of the "carry trade," in which investors borrow a
low-yielding currency like the euro, sell it and then use the proceeds to buy
higher-yielding assets like U.S. stocks and Mexican bonds. Carry trades, which
helped power solid gains in riskier asset classes for the past few years, rely
on a steady interest-rate differential to make money.
But now that the outlook for
interest rates is less certain, investors are scrambling to exit carry trades
before central banks change course. The euro is up nearly 10% since the start
of May against the Australian dollar, a popular carry-trade target.
"The path of least
resistance for the euro is higher," said Bob Marcellus, managing director
at Richmond Optimus, which manages $30 million and is betting the currency will
strengthen.
To be sure, betting on the
euro has its drawbacks. The currency's appreciation isn't a welcome development
for struggling European economies, such as Spain, Portugal and Italy. A
stronger euro makes European exports less attractive to overseas buyers, and
reduces revenue for exporters when they convert their foreign earnings back to
euros.
Also, Italian and Spanish bond
prices have fallen in the past two weeks, a sign that investors still view
parts of the euro zone as risky. MSCI Inc., which publishes
stock and bond indexes tracked by investors managing trillions of dollars,
recently reclassified Greece as an emerging market rather than a developed one.
"It makes sense from an
economic standpoint that the euro should be weaker," said Jeffrey Sica, president
and chief investment officer of Sica Wealth Management, Morristown, N.J.
Mr. Sica has been
betting the euro will fall for two years but said holding that position has
been "torturous."
"All rules have
been thrown out the window," he said. "There are no fundamentals, and
that's making it very, very difficult to be a trader."
The euro's strength is also at risk if the market
stabilizes and investors feel more comfortable putting on carry trades again,
which would mean selling the European currency.
Some investors point to
tentative signs that Europe's prolonged recession may have found a floor.
Euro-zone industrial production rose in April for the third straight month, led
by gains in Germany and France. A leading indicator released last week by the
Organization for Economic Cooperation and Development signaled a return to euro-zone
growth later this year.
The improved data reduce
the odds that the European Central Bank will need to loosen monetary policy at
a time when the Fed is warning it may soon pull back. That preserves a crucial
edge the euro has had over the dollar and yen.
The ECB has refrained
from big stimulus programs, while the Fed and Bank of Japan both are buying billions of dollars in bonds every
month to boost growth. Central-bank stimulus tends to hurt the local currency,
by increasing the amount in circulation. Much of the euro's rise has come since
the ECB's June 6 meeting, where ECB President Mario Draghi said the central
bank wasn't ready to introduce negative deposit rates, a measure aimed at
boosting lending that also could have triggered a drop in the euro.
"They're dealing
with the economy now" in Europe, said Thanos Papasavvas, a strategist at
Investec Asset Management, which manages about $105 billion in assets globally and
currently holds the euro in its currency portfolio. "It will take time,
but it's stable, and I think if anything it's going to be surprising to the
upside."
Other investors cite as
a reason to buy the euro the fact that its value has held up despite a series
of challenges. The currency declined in February after Cyprus took a bailout
and an Italian election failed to immediately produce a new government. But its
slide to just below $1.28 in late March was mild compared with past crises that
knocked the euro to $1.20 or below.
"The system has been tested a bit and it's held
up," said Matthew Alexy, director of global foreign exchange at TD
Securities.
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