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In a research note published this week, London-based strategist George Saravelos said the European single currency could be expected to be trading at around $1.40 now, as investment flows have “swung to a huge surplus”. Instead, it is pinned around $1.10 due to what he describes as a large set of other outflows.
Crucially, he said, Europe has become a big lender to the rest of the world, marking “an important regime break” for the currency. Loans by eurozone banks to non-residents have climbed to levels not seen since 2008, while euro-denominated liabilities of non-EU banks have picked up sharply.
On Deutsche’s estimates, about two-thirds of the eurozone’s €455bn surplus in its balance of payments over the past 12 months can be attributed to such activity.
“No one wants to hold euro cash as an asset any more, but everyone wants it as a liability,” wrote Mr Saravelos. “As a result, the eurozone is emerging as the new global provider of liquidity to the international financial system.”
This shift in the dynamics surrounding the euro is one of the key reasons for its sustained weakness, Mr Saravelos said, as well as a driver of lower volatility in the exchange rate at times when investors are eager to take on more risk in their portfolios. But in a break with typical trading patterns, the currency’s new role also makes it vulnerable to sharp rallies when bouts of financial market nerves strike, he added.
That would make it behave more like the Japanese yen, which has long been a preferred conduit for investors who want to borrow in a low-yielding currency to buy assets offering higher rates: the so-called carry trade.
“The euro is likely to exhibit increasing ‘carry trade’ behaviour where depreciation is gradual but appreciation pressures sharp as positions are unwound,” Mr Saravelos said. [...]
“European banks have opened their lending spigot to the rest of the world again,” Mr Saravelos wrote. “Europe is becoming the world’s new carry trade.”
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