The slide in the euro against the U.S. dollar seen in late 2011 and the early part of this month has petered out in the past few days. It has been slowed by the fact that everybody in the known universe is massively short euros.
Jens Nordvig at Nomura, who has generally been bearish on the euro of late, argues this will likely turn out to be just a pause. His reasoning: Capital flows are negative for the euro.
Lost amid the insane amounts of ink (real and electronic) spilled on the daily ups and downs of the currency markets is that fact that currency markets, and exchange rates, are essentially a transmission mechanism for money flowing between economies and markets.
In Nordvig’s view, the euro will continue to be under pressure as global investors shift money out of the euro zone and in favor U.S. markets.
Here’s some of what Nordvig has to say, first on euro-zone flows and then for the U.S.:
The second half of 2011 was characterized by weakening capital flows into the eurozone. Global investors have been reducing exposure to eurozone sovereign bond and T-bill markets, as well as to eurozone equities. Although the month-to-month data are quite volatile, the broader trend is clear. Foreign investors are reducing their exposure in the eurozone on a broad basis
We believe weakness in the inflow picture has persisted in December and into January. High frequency data from Japan point in this direction, as does the general sentiment among foreign investors globally. In addition … there is evidence that reserve flows are weakening on a trend basis, which should reduce official sector demand for eurozone bonds.
Another important part of the flow picture has been repatriation flows by eurozone portfolio investors. This flow has been particularly visible in equity space, where it was intense in the early phase of equity market weakness, during August .
The new pattern in very recent high frequency data for 2012 indicates that repatriation has stopped. In fact, there is evidence that eurozone investors are again putting capital to work outside home markets.
There are three reasons why we think foreign demand for US assets is improving:
First, the latest high frequency flow data point to increasing outflows by eurozone investors in 2012. Interestingly, it appears that this new accumulation of foreign assets is concentrated in US assets, rather than EM assets. It is early days, but the US share of eurozone outflows has been very high this year (50%), compared with around 25% in previous periods of high outflows.
Second, after a period when the USD share of new reserve accumulation appeared very low (H1 2011), the latest data for H2 2011 suggest that the USD share is normalizing. This could be a function of changing behavior among reserve managers, linked to the tension in the eurozone, or it could be a compositional effect, driven by the greater importance of BoJ reserve accumulation in H2, which tends to be more USD centric than for other central banks on average. In any case, there could be some additional USD demand coming from central banks, especially relative to the very low level observed during the first half of 2011.
Third, US assets have performed well over the past six months on a relative basis, and this outperformance is consistent with macro developments. For example, while both eurozone and EM growth expectations have been revised down significantly over the past three to four months, they have been essentially stable in the US. Increasing capital inflows would be logical in this context.
read more: Olympus Wealth Management
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