Asian demand is likely to drive the euro higher still. Here’s why
The euro has had a good start to 2018 and that may continue. Investors in Asia could well have more euros to buy as Asian portfolio managers may still be materially underweight in the single currency, having scaled back their holdings during the euro zone’s economic crisis and when the US dollar was soaring.
Of course an even stronger euro won’t help euro-zone exporters who sell outside the currency bloc, but that’s not the problem of investors in Asia who might be thinking of adding more euros to their portfolios.
One euro-zone exporter, the French spirits group Remy Cointreau, announced last Friday its results for a third quarter that ended on December 31, saying that the euro’s strength versus the US dollar would have a detrimental impact on its full financial-year profits. It hopes its fourth quarter results will be bolstered by healthy demand for its products over the Chinese New Year.
Meanwhile investors in Asia cannot have failed to notice the upbeat message now emanating from some at the European Central Bank.
“We have definitely left the crisis behind us. Europe is back!” That was the message ECB board member Benoit Coeure chose tellingly to deliver to a Chinese news organisation, Caixin Global, last month.
Coeure added that the ECB’s quantitative easing in the euro zone won’t last forever and that “there is a reasonable chance that the extension of our asset-purchase programme, decided in October, can be the last.” If that turns out to be the case, Asia couldn’t claim it had not been forewarned.
A few judicious observations from a prominent ECB policymaker won’t in isolation trigger an avalanche of Asian demand for the euro but it can help shape market opinion especially if investors are already perceived to be leaning in that direction.
The US dollar itself is anyway already trading on the back foot. Last week saw the yuan rise above 6.40 against the greenback for the first time since December 2015.
As for the euro, previous strength in the dollar occurred against a backdrop of euro-zone crisis and, more pointedly, with the US Federal Reserve starting to tighten monetary policy even as the ECB was still loosening. The euro had plenty of room to make up against the greenback once investors viewed the euro zone’s prospects as picking up.
Sovereign reserve managers, among whom central banks in Asia are prominent, have already started to react.
Analysis by US bank BNYMellon of International Monetary Fund data for the first nine months of 2017 showed that a US$321.7 billion increase in the US dollar value of euros held in known allocations of foreign exchange reserves “can only be partly accounted for by the 11 per cent increase in the value of the EUR against the USD” over the same period. In short, reserve managers have been actively buying euros.
Meanwhile data released last week by the US Treasury showed that the combined share of US Treasuries held by China and Japan in November had dropped to about 36 per cent of the total.
While that still represented some US$2.26 trillion, it was the lowest level for 18 years.
Of course, evidence of past behaviour does not guarantee future repetition but to a market that has already taken the euro higher in value it might suggest that there is still an unsated real demand for the single currency. It could be a comfort blanket for those with euros and a spur to those who so far have remained unconvinced about the higher euro’s staying power.
Some analysts, such as at the Netherlands’ ING Bank, are convinced that although the euro has already moved considerably higher versus the dollar, closing last week above 1.22, it still has room to move higher. ING expects “EUR/USD to break the 1.30 level later this year.” ING may be right.
Admittedly in the very short-term there is event risk surrounding the formation of a new government in Germany and from Thursday’s ECB policy meeting. Beyond that there is the outcome of March’s national elections in Italy to consider.
Yet the currency market may reason that any reversal in the euro’s recent good run will only encourage new or returning buyers, including from Asia, to emerge to take advantage. Dips in the euro’s value could prove to be shallow and short-lived.
If the currency market perceives that Asia still needs euros, it is likely to be quite happy to take the euro higher.