{"id":36162,"date":"2014-08-24T23:53:54","date_gmt":"2014-08-24T21:53:54","guid":{"rendered":"http:\/\/beta.next-finance.net\/strategie\/fundamentals-point-to-a-weaker-euro\/"},"modified":"2019-12-30T23:02:07","modified_gmt":"2019-12-30T22:02:07","slug":"fundamentals-point-to-a-weaker-euro","status":"publish","type":"post","link":"http:\/\/beta.next-finance.net\/en\/strategie\/fundamentals-point-to-a-weaker-euro\/","title":{"rendered":"Fundamentals point to a weaker euro"},"content":{"rendered":"

The region risks falling back into a spiral of
\nlackluster growth, higher deficits and weak investor confidence.
\nThe rescue of Banco Espirito Santo in Portugal sends a warning
\nsign on lingering financial fragility in the periphery despite the
\nrecord tightening in spreads. The EU\u2019s stand-off with Russia over
\nUkraine also looms large over the euro zone economy, with the
\nimpact already apparent in weak order books and industrial
\nproduction in Germany. <\/p>\n

Against this backdrop of negative news flow, the Euro has not
\nweakened as much as we would have expected, with the single
\ncurrency holding steady around USD1.33-1.34[1] for the first two
\nweeks of august, following a move down from USD1.37 since
\nJune.
\n We are underweight the Euro versus the USD in our tactical
\nasset allocation, and believe the fundamentals are firmly aligned
\nfor a further depreciation in the single currency \u2013 in that respect,
\nwe agree with European Central Bank President Mario Draghi
\nwho, unusually for an ECB President, attempted to talk the euro
\nlower in his latest press conference in August.<\/quote><\/p>\n

While the US has characteristically led other regions in the
\nrecovery, the divergence between US and EU zone economic
\nconditions has been unusually wide. While the US posted very
\nstrong Q2 GDP growth of 4 per cent (annualized)[1], parts of
\nEurope are contracting. We have cut our 2014 and 2015 growth
\nforecasts for the euro zone, and now expect economic activity to
\nexpand by 0.8 per cent in 2014 and 1.2 per cent in 2014 (against
\nthe ECB\u2019s more optimistic 1 per cent and 1.5 per cent
\nrespectively). Not only is inflation far behind the ECB\u2019s target at
\n0.4 per cent [1], it also appears that the market has lost faith that
\nthe target is even achievable, with breakeven inflation
\nplummeting across Europe. <\/p>\n

This US-EU zone economic divergence has been reflected in a
\nwidening rate differential, with the bund yield moving to an all-time low. The gap between 2-year rates in the US and Europe has
\nwidened to 44 basis points from 17 basis points[2] at the beginning
\nof the year as the US Federal Reserve moves closer to hiking rates
\nin 2015 and the ECB moves in the opposite direction.<\/quote><\/p>\n

The differential in rates is even wider in the long end of the
\ncurve, where the gap between US Treasury and bund yields has
\nwidened above 140 basis points, a 15y high[2].<\/strong> While we expect
\nthe Fed to wrap up its QE program by October, the ECB is
\nexpected to expand its balance sheet through the deployment of
\nits tLTRO initiative and potential purchases of asset-backed
\nsecurities. Although weak economic momentum and the growing
\nprobability of inflation remaining below target make it
\nincreasingly likely that the ECB will embark on a program of
\nquantitative easing, we do not think this is likely in the near term- the central bank is awaiting further information on measures
\nwhich have already been announced. Even excluding full QE –
\nthe sum total of other measures (including the payback of
\nprevious LTRO tranches) – we expect the ECB\u2019s balance sheet to
\ngrow by around EUR 300-400 billion through the end of 2015,
\neven as the Fed\u2019s balance sheet contracts. Thus, while European
\nfixed income appears to be tracking monetary policy cues, a
\nweaker EUR remains the missing part of the puzzle.<\/p>\n

\"the_euro_has_stayed_ahead_of_the_euro_zone-us_rate_differential.jpg\"<\/p>\n

While a major support for the currency has been strong capital
\ninflows into Europe – especially portfolio flows – there are early
\nsigns that they are ebbing.
\nA combination of geopolitical risks,
\ntepid corporate earnings and deteriorating macro momentum, as
\nwell as the expectation of a weaker euro, has triggered equity
\nselling on the mutual fund and ETF side for the past eight weeks
\naccording to data from EPFR global, with an outflow of USD 7
\nbillion this quarter following steady inflows over the year prior
\nof USD 94 billion in total (equivalent to 15 per cent of net assets)[1]. Bond flows still continue to be supportive, however.<\/quote>
\n Given
\nthat a key source of total inflows has been US investors looking
\nto increase their exposure to Europe, evidence that this source of
\nexternal demand is fading is another justification to go short the
\nEuro from here. <\/p>\n

Besides private capital inflows, the Euro owes its relative
\nstrength to at least two other factors. One, its steady current
\nbalance of around 2.2 per cent of GDP[1] externally, alongside
\ngreater rebalancing occurring among individual countries.
\nSecond, there is anecdotal evidence of the diversification of
\ncentral bank holdings favoring the Euro. While we expect the
\ntrade surplus to stay in place despite a hit to Russian exports, the
\nsecond is more of an unknown quantity, and thus harder to
\nfactor into our calculations. Regarding valuation, our fair value
\nmodels point to an equilibrium level for the EUR at USD1.38, but
\nthis long-term model does not preclude a weaker EUR \u2013 in fact,
\nthe currency needs to be close to 1 standard deviation cheap \u2013
\nequivalent to just over 1.25 to the USD \u2013 in order to have a
\nsignificant impact on the economy and earnings. <\/p>\n

In short, the weight of fundamental factors point towards a
\nweaker Euro.
\nPictet AM\u2019s Strategy unit is currently underweight
\nthe single currency in our grid. In our regional equity grid, we
\nretain a conviction that a weaker euro will go hand-in-hand with
\nweaker European equities for now as the direct currency impact
\ndominates in the short term.<\/quote>
\n Over the medium term, and only
\nonce a sufficiently weak level has been established, a weaker
\nEuro will translate into higher earnings growth, creating a
\nbuying opportunity further down the line. Our fixed income
\ncolleagues are also short the Euro in their portfolios \u2013 they
\nbelieve that further euro weakness will stem from additional
\nsluggish economic data that will lead the market to price in a
\nhigher probability of QE in the first half of next year. <\/p>\n

[1] Source : Bloomberg, Datastream, EPFR
\n
[2] Source : Bloomberg, donn\u00e9es au 20.08.2014 et au 31.12.2013<\/em> <\/strong>