The surging Euro — which is at levels not seen since late 2011 — is one of the biggest stories in global financial markets.
Analysing the factors driving the Euro has become something of an obsession.
Morgan Stanley FX strategist Hans Redeker offered his explanation of why the Euro’s been to strong in a recent note.
He offers a few basic explanations.
One is that the Euro just naturally benefits from US dollar weakness (which is partly the result of the Fed being on hold). There’s also stronger European growth. And then there’s flows from foreign investors (scooping up European assets that are cheap) and banks with weak balance sheets shedding foreign assets and repatriating cash.
First, the EUR is the anti-USD, and with the USD trading south the EUR goes up. Second, the improved European growth outlook has reduced the risk premium for EUR denominated assets. Third, the EUR has benefited from foreign investors buying EUR assets at discounted prices. If you compare the evolution of EURUSD with one year / one year interest rate forwards, EURUSD trades well above the level suggested by rate differentials. The EUR trades at a premium. Why? EMU banks deploy too many assets relative to their equity. For instance, the net foreign asset position has increased to EUR6710 billion. Ahead of Europe’s Asset Quality Review, banks are unlikely to keep this euro short funded position open, as the drain on the banks’ equity ratio coming from this side can be substantial. EMU banks preparing for the Asset Quality Review provided an additional factor driving EURUSD higher as European banks repatriate assets. Of course, repatriation flows are limited by nature, suggesting EURUSD will trade markedly lower in 2014.