ECB’s cur­rency chal­lenge un­der­lined by BoJ’s yen

The Pak Banker - - COMPANIES/BOSS -

When the Bank of Ja­pan gov­er­nor sur­prised in­vestors by adopt­ing neg­a­tive in­ter­est rates on Jan. 29, he spurred only a brief drop in the yen. Then, de­mand for havens surged on con­cern a slow­down in China will stunt global growth and Kuroda's move it­self added to the risk-off mood.

The cur­rency went on to post its best month since 2008. Now Draghi, pres­i­dent of the Euro­pean Cen­tral Bank, will walk the same tightrope, as an­a­lysts pre­dict he's pre­par­ing to cut the euro zone's al­ready neg­a­tive de­posit rate and ex­pand the quan­ti­ta­tive-eas­ing pro­gram he first flagged a year ago.

Cen­tral bankers are quick to stress that cur­rency weak­ness isn't a pol­icy ob­jec­tive, though there's lit­tle doubt it pro­vides wel­come eco­nomic stim­u­lus. In that re­spect, Draghi's move may come against a more be­nign back­drop than Kuroda's, af­ter a rally in stocks and com­modi­ties the past month prompted hedge funds to add to bear­ish euro bets for the first time this year.

"Tim­ing is ev­ery­thing," said Jonathan Lewis, New York-based chief in­vest­ment of­fi­cer at Fiera Cap­i­tal, where he helps over­see about $10 bil­lion. "So many bad things were hap­pen­ing then that it was hard for Kuroda to cut through the noise, whereas Draghi could be more im­pact­ful be­cause the world is com­ing out of its shock from Jan­uary to Fe­bru­ary."

Lewis said he's hold­ing onto po­si­tions that would ben­e­fit from a weaker euro, pre­dict­ing the re­gion's eco­nomic fun­da­men­tals and mon­e­tary pol­icy will push down the cur­rency. The ECB's de­posit rate is al­ready mi­nus 0.3 per­cent and the me­dian es­ti­mate of 58 econ­o­mists sur­veyed by Bloomberg sees it at mi­nus 0.4 per­cent af­ter the cen­tral bank's pol­icy meet­ing ends on Thurs­day.

Draghi will be aware of an­other prece­dent closer to home. Af­ter reach­ing an eight-month low on Dec. 3, the euro jumped 8 per­cent by Feb. 11 as the ECB in­tro­duced less cur­rency-weak­en­ing stim­u­lus in De­cem­ber than some in­vestors pre­dicted. Adding to the ad­vance was a $5.9 tril­lion rout in global stocks in Jan­uary that saw in­vestors un­wind in­vest­ments in higher-yield­ing as­sets that in­volved bor­row­ing and sell­ing Europe's shared cur­rency.

The euro has since dropped 3.5 per­cent to $1.0975 as of 9:25 a.m. Lon­don time on Wed­nes­day. It has fallen in line with JPMor­gan Chase & Co. mea­sure of global for­eign-ex­change price swings, which slipped 1.4 per­cent­age points to 11.1 per­cent, en­cour­ag­ing deal­ers to re-ini­ti­ate some of those volatil­ity-sen­si­tive carry trades.

Us­ing cheap euros to buy emerg­ing­mar­ket cur­ren­cies has gen­er­ated prof­its in 20 out of 22 cases in the past month, with re­turns of as much as 14 per­cent for Rus­sia's ru­ble and 8 per­cent when in­vest­ing in South Africa's rand, data shows.

"Neg­a­tive in­ter­est rates have the most im­pact when they force out risk-averse in­vestors and when there is a bet­ter al­ter­na­tive abroad," said Se­bastien Galy, a strate­gist in New York at Deutsche Bank AG, the se­cond-big­gest cur­rency trader. "Emerg­ing mar­kets are show­ing some signs of sta­bi­liza­tion but it would re­quire an ex­tended pe­riod of calm for flows out of the euro into se­lected parts of emerg­ing mar­kets to build up."

With more than $2.5 tril­lion of eu­ro­zone govern­ment debt yield­ing below zero, it's lit­tle sur­prise the prospect of sell­ing the lo­cal cur­rency to lock in higher yields else­where is ap­peal­ing as price swings in global mar­kets abate.

Hedge funds and other lever­aged in­vestors raised net bear­ish po­si­tions in the euro by 17,495 con­tracts in the week end­ing March 1, the first ad­di­tion since Dec. 29, and boost­ing them from a 1 1/2-year low of 28,185 in Fe­bru­ary, data from the Com­mod­ity Fu­tures Trad­ing Com­mis­sion in Wash­ing­ton show.

This is against a back­drop of longert­erm flows out of the shared cur­rency that may lower the ex­change rate and make it eas­ier for Draghi to meet his goals of boost­ing growth and in­fla­tion. Fixed- in­come out­flows by lo­cal and over­seas in­vestors climbed to 316 bil­lion euros ($347 bil­lion) in the se­cond half of last year, the most for a six-month pe­riod in data go­ing back to the 2008 fi­nan­cial cri­sis.

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