Impending cuts in European interest rates have made the euro a prime candidate for financing carry-trade deals, increasing pressure on the single currency.
The term “Carry-Trade” refers to the process of borrowing in the currency of a country or region with low interest rates and investing the money in another currency that carries higher interest, while benefiting from the interest difference between the two currencies. The success of this trade depends on expectations of trends in the currency borrowed and invested in.
Goldman Sachs Group and JPMorgan recommend borrowing in euros to buy riskier, higher-yielding currencies.
Money managers at “Allspring Global Investments” and “Ninety One Asset Management” prefer to trade against emerging market currencies, while Allspring is also betting on a decline in the euro against the dollar, according to what “Bloomberg” reported, and “Arabia Business” reviewed it.
These convictions received a boost last week, as European Central Bank President Christine Lagarde ended up opening the door to early cuts, helping the euro achieve its worst weekly performance among its G10 counterparts.
The key interest rate in the euro zone is expected to reach 2.5% at the end of 2024, compared to 4% in the United States.
The emergence of the euro as a popular financing currency could have far-reaching consequences. Over the past two years, sub-zero interest rates at the Bank of Japan have meant it costs less to borrow the yen, pushing the currency to its lowest levels in decades. But as traders grow more confident that a rally is coming, they are looking for alternatives.
“The euro faces a number of severe headwinds,” including Germany’s faltering economy and weak private sector activity, said Kamakshya Trivedi, head of global currency, interest rates and emerging markets strategy at Goldman Sachs. “The financing option remains attractive.”
interest rates
Despite her insistence that she would not change her stance on interest rate cuts, Lagarde’s admission on Thursday of faltering economic growth, easing wage pressure and continued slowing inflation was all traders needed to price in a quarter-point cut in April almost completely.
“Growth in Europe appears more risky than elsewhere in the G10,” said Lauren van Biljon, portfolio manager at Allspring Global Investments, adding, “This may create space for the European Central Bank to cut rates in the second quarter, before the United States.” And the United Kingdom.”
Allspring added underweight euro positions against the dollar across global bond portfolios this month.
She said the low volatility of the euro – the implied one-month interest rate against the dollar is near a two-year low – makes it one of van Biljoen’s preferred ways to fund positions in higher-yielding emerging market currencies.
Goldman Sachs is betting on the euro’s weakness against the Indian rupee, expecting it to fall by about 3% to 88 rupees. For riskier trades, they recommend selling the euro against the Mexican peso and the Brazilian real.
At JP Morgan, strategists believe that the strength of the US economy, geopolitical risks, and the weakness of the euro zone are hindering the recovery of the single currency. The currency has fallen by 1.6% since the beginning of the year.
Meera Chandan, co-head of global FX strategy at JP Morgan, said the euro was “better used as a financier rather than a recovery candidate as central banks shift to easy monetary policy.”
While the trade may be more successful when interest rate cuts are officially implemented, it has already paid off relative to the dollar.
Buying high-yielding Argentine pesos with borrowed euros returned 8% this month, compared with 6% if dollars were used instead, according to data compiled by Bloomberg.
Against the yen, this trade achieved a return of 11%.
Different in seriousness
The head of G10 currency research at Credit Agricole Bank said that clients are discussing short selling the euro against the Mexican peso, the real and the rupee.
“These may become more attractive once the BOJ and ECB policy cycles start to diverge seriously from the second quarter,” he added.
Meanwhile, Ugo Lancioni of Neuberger Berman and Michael Sager of CIBC Asset Management say there are better options than the euro. Both favor the Swiss franc, while also suggesting a rise in the Chinese renminbi.
But as the interest rate gap between Japan and Europe narrows, caution seems likely to shift from the yen to the euro.
“The biggest positioning asymmetry over the next 12 to 18 months will be between Europe and Japan,” said Ian Cunningham, head of multi-asset growth at Ninety One Asset Management, who is betting that the euro will fall against the yen.
He added: “For what is priced in, Europe will be forced to ease and Japan to tighten monetary policy.”
2024-01-29 13:27:07
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