Lynn Strongin-Dodds reports how expected rate hikes and a belief the worst has passed for Europe is luring investors back to the euro
The differences in monetary policy across the world are changing foreign exchange investment patterns. While emerging markets have retained their lustre, increasingly investors are moving towards the more developed countries such as the euro on the back of the European Central Bank’s decision to increase interest rates.
For the past year, the sovereign debt crisis particularly over Portugal, Italy, Greece and Spain have overshadowed the European currency but sentiment changed the minute Jean-Claude Trichet, the ECB’s president, signalled earlier this year the bank’s intention to exercise “strong vigilance” over inflation. A one quarter percentage point hike from the record low rate of 1% set in May 2009 is estimated which shook the dollar to its lowest level in 15 months against a basket of currencies and bolstered the euro to its November peak of $1.4282 (as of 22 March) which was its highest level since January 2010.
An interest rate hike though is not the only reason for the euro’s resurgence. The single currency has also benefited along with other developed currencies from the overall migration of flows into more advanced markets from emerging ones. The shift started at the beginning of the year due to an improved economic picture and the Middle East conflict only served to accelerate this trend.
According to figures from data provider EPFR Global in mid-March, fund managers and other investors pulled $2.2 billion from emerging stocks in the days following the Japanese earthquake. Analysts said the trend was consistent with large weekly redemptions seen since the beginning of 2011 where year-to-date outflows of emerging equities were around $25bn.
“Last year, the major theme was the emerging growth story,” said Pareto Investment Management’s chief investment officer, Henrik Pedersen. “This year, where there are more positive signs about the US economy and potential rate hikes in Europe, there has been a shift. The emerging markets are still growing but relative expectations have changed and there has been a realisation that the risk premia was too low. As a result, we are seeing clear outflows of emerging markets to developed markets in equities. This has not translated into all developed market currencies but investors are long the euro because of the expected rate hikes.”
Investec Asset Management’s head of currency management Thanos Papasavvas also believes the euro will continue to be an important currency play for this year. “Having called the euro weakness in the early part of last year following the headwinds of fiscal austerity, we now believe the worst is behind the eurozone, both economically and politically. We expect to see a gradual shift in assets back to the single currency out of peripheral Europe and Switzerland. We also expect to see an increase from reserve banks around the world as they diversify their holdings away from the US dollar, which has its own structural issues of concern.”
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